Why Did the US Federal Reserve’s Latest Rate Cut Spark a Global Market Sell-Off?

On December 18, 2024, the US Federal Reserve made its eighth policy decision of the year, slashing the benchmark interest rate by 25 basis points (bps) to 4.25-4.50%. This move marks the third consecutive rate cut in 2024, aligning with what Wall Street expected. But why did the market react so negatively despite the anticipated rate cut? Let’s break it down:

While the 25 basis point reduction was expected by 97% of market participants, the real shock came from the Fed’s hawkish outlook for 2025. This wasn’t just about the rate cut—it was about what’s coming next. In a dramatic shift, the Fed revised its 2025 interest rate forecast from three expected rate cuts to just two. This means the central bank will only cut rates by 50 bps next year, a significantly more cautious stance compared to previous expectations.

But that’s not all. The Fed also raised its inflation projection for the end of 2025, from 2.1% to 2.5%. This move suggests they are less confident in bringing inflation back to their ideal target of 2% in the near term. Even more concerning is that the Fed anticipates inflation to remain slightly above target in 2026, at 2.1%.

These inflation concerns are what sent shockwaves through the global markets. With inflation still somewhat elevated, investors are now worrying that interest rates might stay higher for longer, dampening the economic recovery. The reaction was immediate: global stock markets tumbled.

How Did the Market Respond to the Fed’s Hawkish Shift?

Despite the rate cut itself being expected, the real turmoil came from the Fed’s inflation projections and 2025 outlook. The S&P 500, one of the most watched indices in the world, posted its largest post-Fed drop since March 2020, erasing a staggering $1.8 trillion in market value. The Dow Jones and Nasdaq also plunged significantly, with the Dow seeing its largest one-day percentage decline since August 5, and the Nasdaq experiencing its worst day since July 24.

So why did the market react so drastically to what seemed like good news—a rate cut? The answer lies in the unexpected hawkish tone of the Fed’s new outlook. Investors had hoped for more aggressive rate cuts in 2025, but instead, the central bank’s more conservative stance suggests they might be prioritizing inflation control over immediate economic stimulus.

Why Are Markets Worrying About Inflation Again?

In simple terms, the Fed’s new outlook reveals a growing concern about inflation. While the central bank has made significant strides in bringing inflation down in 2024, the latest projections indicate that inflation remains a persistent issue. With the Fed expecting inflation to stay above their 2% target through 2026, investors are now asking: Will the Fed have to raise rates again if inflation remains stubbornly high?

This uncertainty has led to volatility in global markets, with many investors wondering if we are heading for a longer period of high rates. The Indian stock market wasn’t immune to the Fed’s decision, with Sensex and Nifty 50 falling more than 1% following the hawkish shift.

What’s Next for the US Economy and Global Markets?

With the US Federal Reserve signaling caution in its future rate cuts and raising inflation expectations, the next few months could be critical in determining the path forward. If inflation remains high, the Fed may be forced to keep rates elevated, potentially putting a drag on economic growth. For investors and global markets, this shift could mean more volatility ahead.

In conclusion, while the Fed’s rate cut was expected, the real market mover was its shift in outlook for 2025 and the renewed concern over inflation. This caution has sparked a broad market sell-off, and as the Fed tightens its grip on inflation, it’s clear: higher rates might stick around longer than many had hoped.