Week of December 23, 2024

Key Points for the Week

• Stocks sold off sharply in reaction to the Fed’s last meeting of the year despite a rate cut and an upbeat economic assessment. • The market sell-off was largely due to the Fed’s expressed uncertainty about inflation and a reassessment of the future path of interest rates. • The change in the Fed’s perspective may lead to bouts of volatility until the Fed does more to support cyclical parts of the economy.

Current Trends & News is a weekly financial recap curated by SPC Financial®’s team of wealth management and tax-integrated advisors.* We monitor and explore the intricacies of the financial world and share insights into market developments.

Economic Update

The Fed met expectations by lowering its policy rate one-quarter of a percentage point during their final policy meeting for 2024, as many economists had anticipated. The federal funds rate is now a full percentage point lower than it was at the start of September.

In later remarks, Fed Chair Jerome Powell confirmed the United States economy remained strong, the jobs market remained solid, and progress had been made toward the Fed’s inflation goals. That was all good news. The upset came when Powell pointed out that inflation remained higher than the central bank’s target and the Fed will “be more cautious as we consider further adjustments to our policy rate.”

Powell’s statement was reflected in the “dot plot,” a scatter chart showing projections for the federal funds rate over the next three years. The chart suggested there may be only two rate cuts in 2025, which is fewer than markets had hoped.

Stocks tumbled 3 [percent] and bonds plunged too, sending yields on benchmark 10-year Treasuries to their highest in seven months…Of course, Powell’s remarks…were not a total blindside. Economic data has been hinting at a resilient U.S. economy, while inflation has remained stubbornly above the Fed’s 2 [percent] target. In the $29 trillion U.S. bond market, traders had pushed yields up some 75 basis points on the 10-year Treasury since the central bank first started cutting rates in mid-September.

Liz Capo McCormick, Michael Mackenzie, Jess Menton, and Alexandra Semenova, Bloomberg

The markets’ malaise deepened as the specter of a holiday government shutdown appeared.

The S&P 500 dipped late Wednesday…after [Elon] Musk and [President-elect Donald] Trump derailed the original spending deal.

Anita Hamilton, Liz Moyer, Bill Alpert, and Callum Keown, Barron’s

A fast-tracked second deal also failed. The chance of a shutdown loomed as markets closed for the week, but policymakers passed a stopgap funding bill just after midnight.”

Christina Wilkie, CNBC

Markets were concerned because government shutdowns hurt the American economy. “A shutdown at the end of 2018 that ran through the new year was partial because five of the government’s 12 appropriation bills had been funded. Even still, the shutdown…reduced the U.S. gross domestic product by $11 billion, according to the Congressional Budget Office.

Dan Rosenzweig-Ziff, The Washington Post

Investors’ spirits lifted on Friday after the Fed’s favorite inflation gauge was released. The Personal Consumption Expenditures Index showed that headline inflation was 2.4 percent year over year, slightly higher than the previous month. However, core inflation, which excludes food and energy, cooled significantly month to month.

Last week, major U.S. stock indices finished lower. The yield on the 10-year U.S. Treasury rose last week, steepening the yield curve, reported Liz Capo McCormick of Bloomberg.

This Week in the Markets

If you looked at markets last Wednesday, you would hardly know that the Fed had just cut rates. The S&P 500 sold off nearly 3% and we saw 97% of all stocks in the S&P 1500 fall.

Worries spiked last week over fears about sticky inflation and fewer rate cuts next year. Putting things into context, the S&P 500 is only 3.6% away from its recent highs and has still had a very strong year.

The Fed upped its view of economic growth and said things looked pretty good on the economic front. In fact, third quarter GDP came in at a very strong 3.1% and has now gained more than 3% four of the past five quarters. Additionally, initial jobless claims fell 22,000 to 220,000 and are at the low end of their range for the second half of the year. Lastly, forward-looking profit margins and earnings for the S&P 500 are both at all-time highs, suggesting the backdrop for this bull market remains quite strong.

Interest Rates and Inflation

Every three months, the Fed updates their Summary of Economic Projections (the “dot plot”), which contains individual member estimates of the fed funds rate over the next few years, and estimates of economic variables (unemployment rate, inflation, GDP growth) under appropriate monetary policy. The last update was in September, and that was widely regarded as dovish. Not so this time around. We saw some big shifts in their thinking, especially about where they estimate policy rates to be in 2025.

In September, the median dot projected the 2025 rate at 3.4%, implying 4 rate cuts (each worth 0.25%-points). In their latest update, they shifted that to 3.9%, i.e. just 2 cuts. The number of participants that are dovish relative to the median also dropped off significantly. Back in September, eight members projected 2025 policy rates below the median. The December median shifted 0.5%-points higher, and only 5 members are below it. That is a hawkish shift across the committee.

Neither did the Fed push the lost two rate cuts out to 2026. They estimated two rate cuts in 2026 in their September dot plot and stuck to that in their latest update. With the 2025 median moving higher to 3.9%, that meant the 2026 rate estimate also moved up from 2.9% to 3.4%.

Interestingly, investors are even more hawkish than the Fed and are currently expecting the policy rate for 2025 to be just over 4%, and no cuts at all in 2026. In short, the economy and markets are looking at elevated interest rates over the next two years.

In fact, markets think interest rates will be elevated even going further out. Investors currently expects policy rates for 2029 to be at 4.05%, which implies investors do not expect any rate cuts beyond 2025. That is significantly more hawkish than the Fed. The Fed’s estimate of the long-run rate is at 3.0%. (It has been gradually moving up from 2.5% over the course of this year.) This move up in estimates of long-run policy rates, by markets and the Fed, is a function of higher estimates of future economic growth (including productivity).

The 10-year Treasury yield can be thought of as a combination of 1) expected short-term policy rates in the future, and 2) a term premium, which captures uncertainty about supply and demand for US Treasuries and inflation uncertainty. A higher expected long-term policy rate should by itself drive the 10-year yield higher, which is what happened recently.

These long-term interest rates matter a lot for the economy. For one thing, an elevated 10-year yield means mortgage rates remain higher, and that is not good for housing affordability. At the same time, elevated interest rates on the back of stronger growth expectations is not necessarily a bad thing. In fact, even for the Fed, December shifts in the dots came about because of:

• More optimism on the economy (though keep in mind that the Fed does not have a GDP growth mandate) • More comfort with where the labor market is • Worries about inflation, and possible upside risk

The first two are positive, but the last one is curious given where the inflation data is.

The Fed’s estimates for their preferred inflation metric, the core Personal Consumption Expenditure Index, was revised higher:

• 2024: Up from 2.6% to 2.8% • 2025: Up from 2.2% to 2.5% • 2026: Up from 2.0% to 2.2%

They expect to hit their target of 2% only by 2027 now. This explains why the dots moved in a more hawkish direction. But Fed Chair Jerome Powell struggled to articulate why they projected even two rate cuts in 2025 if they expected inflation to run at 2.5%, above their target. His answer was that policy would still be “meaningfully restrictive.”

The Fed also thinks there is much more upside risk to inflation now. In September, 8 of 19 members though inflation uncertainty was higher, while 11 thought it was balanced (downside and upside risk about equal). Just 3 of 19 members thought inflation risks were “weighted to the upside.”

In their latest update, 14 of 19 members now think inflation uncertainty is higher. And 15 of 19 members think inflation risks are “weighted to the upside.” That is a big shift, and clearly driven by two things: one, recent hotter-than-expected inflation readings in September and October (though November is expected to be quite soft); two, inflation uncertainty amid tariffs and deficit spending under the new Trump administration.

PCE inflation is elevated right now because of lagging shelter data and financial services (thanks to portfolio management services inflation driven by higher stock prices). Powell did say they will not overreact to a couple of months of inflation prints but it seems like they have done exactly that.

Powell also mentioned that there’s considerable uncertainty about tariffs, including whether we will get any, the type of goods on which it will be imposed, the level of tariffs, and importantly, whether they will add to inflation. Also, deficits have been rising for the last year and half and during that time, inflation has pulled back, a lot. In fact, PCE inflation ran at an annualized pace of 1.5% in Q3 2024, while core PCE ran at 2.1%.

The one positive thing that came out of the Fed meeting was that they do not want to see further cooling in the labor market even as they pulled down their estimates for the unemployment rate in 2025 (from 4.4% to 4.3%), which means the bar for tolerating any downside risk in the labor market is lower.

But there’s confusion even here. Powell noted more than a few times that the labor market is no longer a source of inflationary pressures. i.e. there is no demand-side pressure since wage growth has eased (because labor market demand and supply are more balanced). Crucially, he said they do not need further cooling in the labor market to get inflation to 2%. But this begs the question as to why they think meaningfully restrictive interest rate policy will drive inflation lower.

The pathway by which Fed policy operates is by creating lower demand in interest-rate sensitive areas of the market (like housing and manufacturing), which lowers demand for labor, creating more unemployment and lower demand-led inflation. If they do not want this to happen, and do not think it is even necessary, the question is why they are keeping rates in restrictive territory.

What Country Had the Best Economy in 2024?

Despite high interest rates, stubborn inflation, and wars in Ukraine and the Middle East, there was no stopping the global economy in 2024. In October, the International Monetary Fund forecasted the world economy will grow by 3.2 percent in 2024 with the world’s developed economies growing by 1.8 percent and emerging and developing economies growing by 4.2 percent. The United States was projected to grow by 2.8 percent over the same period.

While the U.S. economy is growing faster than many advanced economies, the United States did not have the best economy in 2024, according to analysis from The Economist. The newspaper reviewed economic and financial indicators, including:

• Gross domestic product, or GDP, which is the value of all goods and services produced by a country, • Stock market performance, • Core inflation, • Unemployment, and • Government deficits, which is the difference between what a government receives and what it spends.

When the analysis of 37 nations was complete, The Economist determined that Spain had the “best” economy for 2024.

While Europe’s other large economies are plunged in gloom, Spain’s is soaring. It is set to grow 3 [percent] this year…almost four times the euro-area average. Hit harder than most by the pandemic, it now boasts 1.8 [million] more jobs than at the end of 2019. Investors have noticed: with faster growth and a lower fiscal deficit than France, Spain has seen its bond yields dip below those of its northern neighbor for the first time since 2007.

The Economist

Ireland, Denmark, Greece, and Italy rounded out the top five. The United States landed in 20th position. The U.S. had higher inflation than most of the top five, a slightly higher unemployment rate, and a much higher deficit, which offset solid economic growth and extraordinary share price gains. Three of the top five economies had budget surpluses last year.

A Reminder About Scams

Scams usually start with a phone call, email, text, or another form of communication. The person typically claims to be from an agency or organization you know – or one that sounds like it might benefit you, such as the National Sweepstakes Bureau or a lottery.

The person may know your name and address. They may give you their official title or an identification number. No matter how official they seem, you can be confident it is a scam if the person contacting you:

• Indicates there is a problem with your benefits. • Asks you to pay to receive a prize. • Suggests that paying will increase the chance of winning. • Requests financial information, such as a bank account or credit card number. • Pressures you to act immediately. • Tells you to pay using a specific method, such as a gift card or cryptocurrency.

If this happens, remember that the Social Security Administration, the Internal Revenue Service, Medicare, and your bank do not call, email, or text to ask for money or personal information. They do not demand that you pay immediately, and they do not accept payment by gift card, prepaid debit card, cryptocurrency, or another untraceable form of money transfer.

When you suspect a scam:

• Hang up or close the message. Do not respond in any way. • Remain calm. • Think back over the call. Write down any personal information you may have inadvertently shared. • Report the scam. Contact the Federal Trade Commission at ReportFraud.ftc.gov. You may also want to report the incident to your state’s attorney general or your local consumer protection agency. • Share your knowledge. Talk with family, friends, and neighbors about your experience so they know what to look out for.

When you receive a digital message, no matter how official it seems, do not click on any links. Do not give or confirm any personal information, including your name, birth date, phone number, address, email address, place of birth, driver’s license, passport, or Social Security numbers, bank or other account numbers, and PIN numbers.

Being skeptical can keep you safe. Remove yourself from the situation. Do not share information. If you feel anxious and need to confirm that it was a scam, contact the organization using a method provided on their official website.

How To Avoid Tax Scams

Below is a link to a video provided by the IRS to help avoid tax scams:

https://www.youtube.com/@irsvideos

If you have any questions, please contact us.

Did you Know? This Week in History

December 27, 1932: Radio City Music Hall Opens

At the height of the Great Depression, thousands turnrf out for the opening of Radio City Music Hall, a magnificent Art Deco theater in New York City. Radio City Music Hall was designed as a palace for the people, a place of beauty where ordinary people could see high-quality entertainment. Since its 1932 opening, more than 300 million people have gone to Radio City to enjoy movies, stage shows, concerts and special events.

Radio City Music Hall was the brainchild of the billionaire John D. Rockefeller, Jr., who decided to make the theater the cornerstone of the Rockefeller Complex he was building in a formerly derelict neighborhood in midtown Manhattan. The theater was built in partnership with the Radio Corporation of America (RCA) and designed by Donald Deskey.

In its first four decades, Radio City Music Hall alternated as a first-run movie theater and a site for gala stage shows. More than 700 films have premiered at Radio City Music Hall since 1933. In the late 1970s, the theater changed its format and began staging concerts by popular music artists. The Radio City Music Hall Christmas Spectacular, which debuted in 1933, draws more than a million people annually. The show features the high-kicking Rockettes, a precision dance troupe that has been a staple at Radio City since the 1930s.

Weekly Focus

We cannot cure the world of sorrows, but we can choose to live in joy.

Joseph Campbell, Writer

The best and most beautiful things in the world cannot be seen or even touched, they must be felt with the heart.

Helen Keller, Author and Disability Rights Advocate