Fed Hikes 0.75% as Expected, but Tough Language Pressures Stocks

The setup for a huge interest rate hike and an ultra-hawkish Federal Reserve stance was in place, it seemed, as the Federal Open Market Committee (FOMC) met to establish America’s monetary policy today. With the Dow Jones Industrial Average (DJIA) gaining 14% in October and the Personal Consumption Expenditures (PCE) index printing a lofty 5.1% in September, it felt like the U.S. Federal Reserve (or “Fed”) had little choice but to raise the federal funds rate by 75 basis points today.

Indeed, that’s exactly what the Fed did as the central bank raised the federal funds rate, which is the interest rate that U.S. banks charge each other for overnight loans, by 75 basis points (bps) or 0.75%. The federal funds rate is significant because it influences other lending rates, such as for auto loans, credit cards, and mortgages.

The 75 bps hike is a big one, and it’s the fourth one in a row. However, the markets had largely expected this and had already rotated out of growth stocks and into defensive names. After the FOMC released its statement, though, a risk-on feeling promptly entered back into the financial markets.

The Fed Signals a Potential Policy Change, but Powell Talks Tough

Hardly anyone is expecting a full “pause” in interest rate hikes or a “pivot” back to easy money policy during the upcoming December FOMC meeting. Yet, stock traders had hoped to find something to signal an easing of aggressive rate raises in the near future – and they found what they were looking for with a single word.

While the watchword in past Fed statements was “data-dependent,” this time, it was “lag.” Thus, the FOMC promised to “take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

In other words, the Federal Reserve isn’t just going to plow ahead with jumbo-sized interest rate hikes without taking the economy’s well-being into consideration. At least, that’s how stock traders seemed to interpret the Fed’s statement today.

This prompted a brief rally in stocks, but then Federal Reserve Chairman Jerome Powell came out and made a statement that threw cold water on any temporary risk-on sentiment. Specifically, Powell warned that it’s “premature” to talk about pausing hikes and that “We have a ways to go” in that regard. These words caused stocks to quickly move from green to red, with the S&P 500 down 1% by 3:00 p.m. Eastern Time.

Powell further predicted, “incoming data since our last meeting suggests that the ultimate level of interest rates will be higher than previously expected.” Thus, the Fed might target a “terminal” federal funds rate of 5% or even higher than that. So, we’ll all have to stay tuned and see whether the central bank continues on its aggressive course and how much lower stocks will fall in response.