Fed’s Interest-Rate Rumble: Stock Market on Alert for Reality Check

This week, U.S. investors are gearing up for a significant moment as the Federal Reserve unveils its updated projections for interest rates. The burning questions on everyone’s mind revolve around the shifts in the ‘dot plot’ and how Fed Chair Jerome Powell will address these changes.

With inflation persistently above the 2% target, investors are eager to gauge if policymakers still anticipate three rate cuts in 2024. Recent data indicating continued inflationary pressures has led to concerns among investors, who previously anticipated an interest-rate cut by June. Now, there’s apprehension that the Fed might delay such moves.

The Fed’s policy rate is expected to remain steady within a range of 5.25% to 5.5% following the two-day meeting concluding on Wednesday. Consequently, all eyes will turn to the release of the Fed’s latest Summary of Economic Projections, with particular focus on the “dot-plot” revealing individual policymakers’ forecasts for the future fed-funds rate.

Thierry Wizman, global FX and rates strategist at Macquarie, suggests the possibility of the Fed postponing rate cuts until midyear, emphasizing the need for additional evidence of sustainable disinflation before any adjustments.

Recent trends indicate a slowdown in disinflation, potentially prompting Fed officials to revise upward their projections for 2024 and 2025. Initially, the Fed had anticipated a total of 75 basis points of cuts in 2024 and 100 basis points in 2025, but market sentiment has shifted with expectations now aligned with three quarter-point cuts in 2024.

Interestingly, despite concerns over inflation, the stock market has remained buoyant. However, the government-debt market has shown signs of anxiety, particularly following notable increases in Treasury yields.

Looking ahead, the potential adjustment of the neutral rate by the Fed could have significant implications for both bond and stock markets. A higher neutral rate could translate to fewer interest-rate cuts in the future, affecting market dynamics.

As investors brace for the Fed meeting, caution is advised, particularly regarding bond investments. Increased apprehension among traders might trigger a selloff in the government-debt market. Furthermore, any indications of a higher long-term neutral rate could exert downward pressure on stocks, impacting their recent upward trajectory.

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