December Fed Rate Cut and Washington Budget Battle

Question: Why did markets react negatively to the Fed's latest cut?

Thanks for the important question about monetary policy and market sentiment. The Federal Reserve's recent actions and communications affect both the markets and economy, especially as we head into 2025. Let me break down the key points to help provide perspective.

• The Fed cut rates by 25 basis points to 4.25%-4.50% at its December meeting, marking a full percentage point in cuts since September 2024, but Fed Chair Powell signaled more caution about future cuts amid sticky inflation readings.
• The latest economic data shows mixed signals - November CPI remained elevated at 2.7% year-over-year with core at 3.3%, while the job market showed strength with 227,000 new jobs and 4.0% wage growth in November 2024.
• Markets initially reacted negatively to the Fed's more hawkish tone and reduced rate cut projections for 2025, with the S&P 500 falling nearly 3% after the announcement, though stocks have shown more recent signs of recovery. This is because markets are adjusting to fewer rate cuts next year, with current market-based measures suggesting that there may only be one or two.

The included chart shows how Fed expectations have shifted. Their latest Summary of Economic Projections shows that the committee only expects two rate cuts in 2025. This means the fed funds rate may be higher in the long run than many investors and economists had previously expected.

While short-term market reactions to Fed decisions can be volatile, history shows that maintaining a long-term investment perspective during periods of policy uncertainty is usually the wisest approach.

Question: How do Washington budget battles affect investors?

Thanks for the important question about how federal budget negotiations and political standoffs impact markets. While these events often generate dramatic headlines and short-term market swings, history shows that markets have generally remained resilient through various political and fiscal challenges. Let's examine some key facts to provide perspective:

• The government needs to pass a spending bill to keep agencies and services funded. However, Congress can pass "continuing resolutions" to keep the government open for a few months at a time, which is what it did back in September. A new deadline is now approaching, threatening a government shutdown.
• While government shutdowns are by no means positive, markets have historically performed well despite these and other fiscal events. The recent Fitch downgrade of U.S. debt to AA+ in 2023 serves as an example of how markets can weather even the worst headlines.
• The federal budget deficit reached $1.8 trillion in the most recent fiscal year, driven by higher interest costs and spending on programs for older Americans. While this presents long-term challenges, markets have continued to function normally.
• A separate issue is that the debt ceiling will be reinstated in January 2025. The debt ceiling limits how much the government can borrow to pay its bills. During past debt ceiling crises, markets have generally remained stable, with the notable exception of 2011 when a U.S. debt downgrade led to a market correction.

The included chart shows the size of the U.S. budget deficit in recent years. Much of the disagreement in Washington stems from how best to control spending.

Rather than reacting to political headlines, investors are typically better served by maintaining diversified portfolios aligned with their long-term financial goals and focusing on time-tested investment principles.