The Federal Reserve cuts interest rates, but the “hawkish” forecast hits stocks and sends the dollar higher

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The Federal Reserve cut interest rates by a quarter of a percentage point but announced a slower pace of easing next year, pushing the dollar to a two-year high and triggering a selloff in U.S. stocks.

The Federal Open Market Committee voted on Wednesday to cut the benchmark rate to 4.25 percent to 4.5 percent, the third reduction in a row. Cleveland Fed President Beth Hammack cast a dissenting vote, preferring to keep interest rates stable.

Officials’ forecasts for interest rates in 2025 also suggest smaller cuts than previously forecast, underscoring policymakers’ concerns about persistent inflation. In a sign of these concerns, policymakers also raised their inflation estimates for next year.

“This was a blatantly aggressive message from the Fedsaid Aditya Bhave, senior U.S. economist at Bank of America, adding that officials’ forecast for two quarter-point interest rate cuts in 2025 instead of the three expected by some economists represented a “big shift.”

JPMorgan Chase, one of the largest players in US bond markets, noted that money markets expect cuts of just 0.31 percentage points in 2025. The bank said that was “significantly more restrictive” than its forecast of 0.75 percentage points, clarifying the extent of the shift.

Wall Street stocks fell sharply after the decision: The S&P 500 fell nearly 3 percent and the tech-heavy Nasdaq Composite lost 3.6 percent. Many of the biggest winners of a strong stock rally in 2024 withdrew: Elon Musk’s car maker Tesla fell 8.3 percent, Facebook parent Meta lost 3.6 percent and Amazon gave up 4.6 percent.

Shares of smaller publicly traded companies, considered particularly sensitive to fluctuations in the U.S. economy, took a heavy hit, sending the Russell 2000 down 4.4 percent.

U.S. Treasury bonds also fell in price, with the policy-sensitive two-year Treasury yield rising 0.11 percentage points to 4.35 percent. The dollar rose 1.2 percent against a basket of six currencies to its highest since November 2022.

The U.S. currency has risen since Donald Trump’s election victory last month on expectations that tariffs will trigger a new surge in inflation, but Wednesday’s Fed decision “adds more fuel to the fire,” said Mike Pugliese, senior economist at Wells Fargo.

After Wednesday’s move, Fed Chairman Jay Powell said the central bank’s monetary policy settings were “significantly less hawkish” and policymakers could be “more cautious” when considering further easing. The December decision was a “closer decision” than previous meetings, he said.

Inflation is moving “sideways,” Powell added, while risks to the labor market have “reduced.”

The Fed’s goal is to put enough pressure on consumer demand and business activity to drive it forward inflation and thus return to the Federal Reserve’s 2 percent target without harming the labor market or the economy in general.

The core personal consumption expenditures price index, the Fed’s preferred inflation gauge that excludes food and energy prices, rose at an annual rate of 2.8 percent in October.

Concerns about inflation stalling above 2 percent contributed to Fed officials forecasting half a percentage point worth of cuts in 2025, which would bring the central bank’s key interest rate to between 3.75 and 4 percent.

Powell also noted that officials have begun incorporating assumptions about Trump’s planned policies into their forecasts.

Four policymakers planned one or no quarter-point cuts next year. Fed officials had forecast a full percentage point of rate cuts in 2025 in the previous “dot plot” released in September.

Wednesday’s forecasts showed that most officials expect the key interest rate to fall to 3.25 to 3.5 percent by the end of 2026, also higher than their previous forecast.

They also raised their forecasts for core inflation to 2.5 percent and 2.2 percent in 2025 and 2026, respectively, and predicted that the unemployment rate would remain stable at 4.3 percent over the next three years.

The Fed began a rate-cutting cycle in September with a record half-percentage point cut, but since then labor worries have eased and the economic outlook has brightened. The economy’s resilience to higher borrowing costs has changed the calculations of officials as they try to find a “neutral” interest rate that neither restricts nor pushes up growth too much.

The central bank has described the latest cuts as a “recalibration” of monetary policy, reflecting its success in bringing inflation down from a peak of around 7 percent in 2022.

Powell said Wednesday the Fed is in a “new phase of the process” as borrowing costs approach the neutral rate.

Fed officials again raised their estimate for the neutral interest rate, with the majority now putting it at 3 percent, up from 2.5 percent a year ago.

The Fed meeting came just weeks before Trump returned to the White House after promising to raise tariffs, deport immigrants and cut taxes and regulations. economists recently queried According to a Financial Times report, the policy combination could trigger a new spike in inflation and hurt growth.

Additional reporting by Eva Xiao in New York