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(Bloomberg) -- Almost exactly one year after sparking a furious rally in financial markets, Federal Reserve Chair Jerome Powell did the exact opposite on Wednesday, staking out a cautious view on interest-rate cuts in 2025 that stunned investors.
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Stocks tumbled 3% and bonds plunged too, sending yields on benchmark 10-year Treasuries to their highest in seven months. By the time Powell was done speaking, some 90 minutes after the Fed announced its third rate cut in a row, the selloff was the worst after a meeting since the onset of the pandemic and the message was clear: The go-go, risk-on rally of the past two-plus years is suddenly in peril.
The turmoil is testament to just how much faith markets were putting in a steady stream of policy easing to buoy asset prices. Now, with officials predicting just a pair of rate cuts over the next 12 months, those hopes have been all but dashed, and investors have been left to pick up the pieces and figure out where to go from here.
“The markets weren’t set up for this Fed announcement,” said Tom di Galoma, head of fixed income at Curvature Securities. “Powell is moving to neutral and waiting for the next administration to push their agenda and see then what he may need to do.”
Of course, Powell’s remarks around a “new phase” of monetary policy during Wednesday’s news conference weren’t a total blindside. Economic data has been hinting at a resilient US economy, while inflation has remained stubbornly above the Fed’s 2% target. In the $29 trillion US bond market, traders had pushed yields up some 75 basis points on the 10-year Treasury since the central bank first started cutting rates in mid-September.
But even they were caught off guard by how close officials now appear to be to the end of their cutting cycle.
The swaps market now implies fewer than two quarter-point reductions for the entirety of 2025, even less than what was implied in the Fed’s so-called dot plot on Wednesday. In the options market linked to the Secured Overnight Financing Rate, one large block trade placed Wednesday afternoon even stands to benefit from the start of another hiking cycle next year.
“It sounds like the Fed is going to take a very conservative pathway forward,” said Chris Ahrens, a strategist at Stifel Nicolaus & Co. “Inflation has proven more resilient than they had thought and impending political dynamics have increased the near-term forecasting difficulties.”
Of course, both the Fed and the markets’ outlooks have to be taken with an element of flexibility. President-elect Donald Trump, who will re-enter the White House in little over a month, has vowed to ramp up tariffs on top US trading partners and slash taxes — both policies that economists say have the potential to stoke inflation.