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The dollar soared to a two-year high and U.S. stocks fell as the Federal Reserve cut its benchmark interest rate by a quarter of a percentage point but signaled the pace of easing next year would slow.
The Federal Open Market Committee voted Wednesday to cut the federal funds rate to 4.25% to 4.5%, the third consecutive cut. The decision was not unanimous, with Cleveland Fed President Beth Hammack voting against it in favor of keeping rates unchanged.
Officials’ economic outlook, released at the same time as the interest rate decision, showed the cut in 2025 would be smaller than previously expected, warning that lowering borrowing costs too quickly would curb price increases across the world’s largest economy. This highlighted concerns among policymakers that efforts to improve the economy could be undermined. Policymakers also raised their inflation forecasts.
After the decision, Wall Street stocks plummeted, with the S&P 500 index dropping nearly 3%. Many of the biggest winners from the 2024 mass rally have withdrawn. Elon Musk’s automaker Tesla fell 8%, Facebook parent company Meta fell 4% and Amazon fell 5%.
Prices of US government bonds also fell, with the policy-sensitive two-year government bond yield rising 0.11 percentage points to 4.35%. The dollar rose more than 1% against a basket of six peer countries, hitting its highest since November 2022.
The dollar has strengthened since Donald Trump won last month’s election on hopes that his tariff threats would spark higher inflation, but Wednesday’s Fed decision “adds fuel to the fire.” ” said Mike Pugliese, senior economist at Wells Fargo.
Fed Secretary Jay Powell said Wednesday’s interest rate cut would make the central bank’s policy settings “much less restrictive” and policymakers could be “more cautious” when considering further easing. said. He also characterized the December decision as “closer call” than previous meetings.
Powell added that risks to the labor market are “reducing” while inflation remains “flat.”
Wall Street bank Morgan Stanley said the Fed’s 2025 forecast was “much more hawkish than we expected.”
The Fed’s goal is to put enough pressure on consumer demand and business activity to bring inflation back to the U.S. central bank’s 2% goal without causing widespread harm to the job market or the economy.
Officials now expect the benchmark interest rate to be cut by half a percentage point next year to between 3.75% and 4%, which would be lower than the full cut predicted in September’s Dot Plot. Four officials decided to make one additional cut or none at all next year.
Most expect the policy rate to fall to 3.25-3.5% by the end of 2026, also higher than expected three months ago.
It also predicted that inflation expectations would rise to 2.5% and 2.2% in 2025 and 2026, respectively, after lower food and energy prices, while the unemployment rate would remain stable at 4.3% over the next three years.
“In considering the extent and timing of further adjustments to the target range for the federal funds rate, the Committee will carefully evaluate available data, developments in the outlook, and the balance of risks,” the committee said.
In a sign that the Fed is preparing to hold off on cutting interest rates at an upcoming meeting, the FOMC revised language in its statement regarding future changes in policy settings.
Wednesday’s decision is not the first time this year that Fed officials have disagreed, after Michelle Bowman challenged September’s half-point cut. This is the first time since 2005 that a governor has voted against a decision.
The quarter-point rate cut was widely expected in financial markets and came as officials debated how quickly inflation was retreating toward the Fed’s 2% target. . The core personal consumption expenditure price index, the central bank’s preferred measure of inflation that subtracts food and energy prices, rose at an annual rate of 2.8% in October.
Since the Fed began a new rate-cutting cycle in September with a sharp half-point cut, concerns about the labor market have subsided and the economic outlook has brightened. The health of the U.S. economy has changed officials’ calculations to settle on a “neutral” interest rate that won’t throttle growth or get too high.
The central bank described its recent interest rate cuts as a policy “recalibration” reflecting its success in bringing inflation down from its peak of around 7% in 2022.
Chairman Powell said Wednesday that the Fed is entering a “new stage in the process,” suggesting that the bar for future rate cuts will become even higher as rates move closer to the expected neutral rate.
Fed officials have raised their expectations for the neutral rate again, with a majority now pegging it at 3%. This time last year, they measured it to be 2.5%.
The Fed meeting was held weeks before President Trump returned to the White House, vowing to raise tariffs, deport immigrants and cut taxes and regulations. In a recent Financial Times poll, economists said this combination of policies could trigger a new surge in inflation and hurt growth.
Additional reporting by Eva Xiao in New York
