Why the Fed Paused Rates But Stocks Went Down

The Federal Reserve chose not to increase interest rates during the latest FOMC meeting, yet the stock market experienced a decline. Some investors might be wondering why, considering that this should be a piece of positive news.

We must remember that the market is forward-looking and would price its expectations accordingly, often before the event happens.

In this particular instance, the market was not reacting to the current FOMC decision but was instead preparing for future ones. The present pause in interest rates had already been anticipated and factored into the market's calculations. In fact, the futures market for the Fed's interest rates indicated an over 80% probability that rates would remain unchanged, and that prediction proved accurate.

But what the market didn't expect was the Fed's hawkish tone for the future. This has necessitated a recalibration of the interest rate expectations for the upcoming year in response to this new information.

During the meeting, the Fed Committee will release their expectations for future Fed fund rates, providing insights into the direction of interest rates. These expectations are compiled into what is known as a "dot plot." The most recent dot plot reveals that the committee anticipates one more rate hike in 2023.

There are two more meetings scheduled for this year, one in November and another in December. Market expectations for November have seen little change, suggesting the Fed is likely to pause the rate hike during that month. However, the probability of a 0.25% rate hike in December 2023 has risen from 38.9% to 40.4%, implying that if a rate hike is indeed on the horizon, it is most likely to occur in December.

One of the more concerning aspect is the Fed's anticipation of maintaining elevated interest rates for an extended duration, as indicated by the dot plots provided below. Following each FOMC meeting, there has been a noticeable increase in the projected rates for 2024 and 2025. This surge in expectations is a key factor contributing to the rise in long-term bond yields.

Investors have been waiting for a rate cut, but one would have to wait longer because the latest adjustment shows that a rate cut is delayed by 4 months. Before this FOMC meeting, the market had expected a rate cut in May 2024. However, it is now more likely to occur in September 2024.

Given this "higher for longer" adjustment, growth stocks, REITs, and highly-indebted stocks may face more headwinds going forward. Nonetheless, it's important to note that this isn't necessarily a doomsday scenario; it's more of an extension of the ongoing stock market correction as markets adapt to these new expectations. My stance remains bullish.