Last Wednesday, the three major U.S. stock indices finished on a high note, with the Dow Jones surging by 500 points to reach a record level. Meanwhile, the U.S. dollar and bond yields dipped, and spot gold climbed 1.3%, surpassing the $2,000 mark once more.

The buzz driving the market's surge centered on the widely discussed possibility of interest rate cuts.

With that backdrop, we'll delve into the Federal Reserve's FOMC meeting outcomes from Wednesday and explore how their statements uplifted investor confidence.

The Federal Reserve has hinted that interest rate cuts could be on the way

1. One of the factors for the interest rate cut: CPI data as expected

The Consumer Price Index (CPI), a closely watched inflation gauge, was released on December 12th, which was the same day as the FOMC meeting. In November, CPI rose by 3.1% from a year ago, which was slightly lower than the previous month's increase of 3.2%. Excluding volatile food and energy prices, the core CPI rose by 4% year-on-year.

The CPI data met market expectations, which provided further support for the Fed's decision to remain unchanged at the FOMC meeting.

1. Another factor for the interest rate cut: Cooling of the labor market

In our latest analysis, "[Insights for Dec. 2023] How Tightened Financial Conditions May Affect The Fed's Monetary Policy" we noted that while the labor market has shown some resilience in 2023, job growth has decelerated.

The release of three employment reports in December provides some clues:

• The latest Job Openings and Labor Turnover Summary (JOLTS) shows that job vacancies dipped to 8.733 million in October, which is lower than the expected 9.3 million. This represents the lowest level of job vacancies in two and a half years.

• ADP's non-farm private employment posted a gain of 103,000 jobs in November, which is slightly slower than the 106,000 new jobs added in October. This was also lower than the expected 130,000, marking the second smallest monthly increase since January 2021.

• The non-farm payroll report showed that after seasonal adjustments, the number of non-farm jobs increased by 199,000 in November, exceeding the Dow Jones' forecast of 190,000, and surpassing October's figure of 150,000. Due to a slight increase in labor force participation, the unemployment rate edged down to 3.7%, below the projected 3.9%.

Although two of the three data points showed a slowdown in employment, one showed employment still growing faster than expected, the market recognizes that the job market is steadily recovering compared to the previous two years. The slightly higher-than-expected non-farm payroll data did not change the stock market's positive outlook, as many investors still believe that the Fed will cut interest rates next year.

FOMC meeting appears to have ignited market optimism

As anticipated, the Federal Reserve opted to hold its key interest rate at its 2022 peak during its year-end meeting in 2023. This marks the third instance this year of the Fed maintaining a steady rate.

In the subsequent press conference, Fed Chairman Jerome Powell reported that inflation had receded from its peak and that there had been no significant uptick in unemployment, which bodes well. Addressing queries regarding interest rate reductions, Powell clarified that while declaring victory was premature, discussions about potential rate cuts were underway.

In essence, Jerome Powell's reference to "discussing interest rate cuts" for the first time was interpreted as an encouraging signal by investors.

In addition to the Federal Reserve's statement, they released their 2024 economic forecast report which was highly anticipated by the market. The dot plot within the report suggests a consensus among Federal Reserve officials that the current cycle of rapid rate hikes is concluding.

Furthermore, the dot plot offers additional optimism as most Federal Reserve officials anticipate lowering interest rates three times in the coming year. This news should be seen as a source of comfort for investors who have been awaiting rate reductions.

The news indicating the potential for rate hike ending and interest rate cut expected generated cheers from investors and led to a rise in Wall Street stock markets. All three major US stock indices rose, with the Dow Jones up by 500 points, breaking through the 37,000-point mark for the first time and setting a new record high.

Gina Bolvin, CEO of Bolvin Wealth Management Group, wrote in a report, "The Fed has given the market an early holiday gift today when, finally, for the first time, they have commented positively about inflation."

When to cut interest rates becomes a new challenge

Typically, the Fed may consider cutting interest rates for several reasons, such as a significant rise in unemployment during a recession or when inflation aligns with the Fed's 2% target.

Should the Fed delay rate cuts in these scenarios, the economy could struggle under the weight of high interest rates coupled with subdued inflation.

Regarding the criteria for cutting interest rates, Jerome Powell mentioned that although the Fed hopes to reduce inflation to 2%, waiting until inflation reaches 2% before cutting interest rates would be too late. According to the economic forecast report, the Fed's preferred inflation indicator, the PCE price index (Personal Consumption Expenditures Price Index), will decline from 2.8% in 2023 to 2.4% in 2024.

Vanguard analysts believe that achieving the last mile towards 2% inflation will be the most challenging.

For now, investors should monitor upcoming inflation data to glean insights into the likelihood of future rate cuts.

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