Sunday, December 22, 2024

Fed on Hold, Washington Now The Issue

The stock market rally looks to be intact after last week's extreme volatility.  Although news commentary blamed the Fed for last Thursday's sell-off, the budget crisis was likely the real culprit.  The FOMC Meeting outcome was essentially as expected and arguably a market positive, while Trump's opposition to the proposed budget resolution was not on either count.  Although the budget issue was eventually resolved, Trump's opposition highlighted the possibility of more discord in Washington, which would not be good for stocks ahead.  In particular, the potential for a trade war between the US and its major trading partners could weigh on stocks at some point.

The bottom line from this week's FOMC meeting was not bad for the stock market.  The Fed's downshift in next year's projected pace of rate cuts should not have precipitated such a sharp drop in stocks.  First, it was widely expected.  Second, one reason for the downshift was the continuing strong US economic growth -- a market positive.  Moreover, Fed Chair Powell's comments suggest the Fed will act if needed to sustain the strong growth next year -- reducing downside risks in the outlook.  Along with the likelihood of policy easing by other central banks, the overall stance of monetary policy appears to be pro-growth globally.  

Although the Fed raised its inflation forecast a bit for 2025, Powell emphasized that officials are confident that the trend is down and that their 2% target will be met.  His comments suggest the Fed will continue to downplay outliers and quirks in inflation data, such as the tendency for start-of-year price hikes.  The modest 0.1% m/m prints for November PCE Deflator offers support for his outlook.

Despite Powell's insistence that policy is based on the economic outlook, the Fed's forecasts have little credibility.  They consistently failed to pick up the economy's strength this year.  Even the latest forecast of 2.4-2.5% for 2024 Real GDP Growth appears too low,  Real GDP Growth would be 2.7% in 2024 (Q4/Q4) if the Atlanta Fed's forecast of 3.1% for Q424 is right.  In the same vein, the Fed's projection of two rate cuts in 2025 shouldn't be viewed seriously.  Whether and by how much rates are cut will depend on how the economy evolves, which no one (including the Fed) knows for sure.  At this point, the significance of its rate projection is that monetary policy leans toward pro-growth, ready to ease further if the economy weakens.

Powell said that Fed staff has been working to determine the potential channels through which tariffs could impact the economy.  He admitted that the impact on inflation and growth is not clear, in part because it could depend on whether other countries retaliate.  Other issues are whether the tariff's impact on inflation would be one-off or sustained.  The continuing strengthening of the dollar is already an offset.  A trade war would be a problem for stocks, even if the effects on the economy are not seen immediately or turn out to be minor. 


 

 

 




 

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