Did the market overreact to the Fed’s comments?

Markets fell Wednesday and plunged in the afternoon after the Federal Reserve decided to keep interest rates at their current levels.

On Wednesday, the S&P 500 fell 79 points, or 1.6%, to close at 4,845, while the Nasdaq Composite closed down 346 points, or 2.2%, at 15,614. Additionally, the Dow Jones Industrial Average fell 317 points, or 0.8%, to 38,150.

There has been somewhat irrational enthusiasm that the Federal Reserve may begin cutting interest rates as early as March. But the central bank poured cold water on this, which may have accelerated the decline on Wednesday afternoon.

Chances of interest rate cut in March are low

The Federal Reserve has maintained the federal funds rate at 5.25-5.5% for four consecutive times since raising interest rates in July. Although not unexpected, the market appears to have interpreted the Fed’s comments and statements in a more hawkish tone.

“The economic outlook remains uncertain and the committee is paying close attention to inflation risks,” the Federal Reserve said in a statement. “The Committee does not expect that it would be appropriate to reduce the target range until greater confidence is obtained that inflation will continue to move towards 2%. Additionally, the Committee will continue to reduce its holdings of Treasury securities, agency bonds, and agency mortgage-backed securities as described in its previously announced plan. “The Committee is committed to returning inflation to the 2% target.”

In fact, inflation rose to 3.4% in December from 3.1% in November, likely influenced by the Fed’s hawkish stance. The economy also grew faster than expected in the fourth quarter, with gross domestic product (GDP) recording 3.3%, ahead of the expected growth rate of 2.2%.

Federal Reserve Chairman Jerome Powell was even more pointed in his own language, declaring at a press conference following the central bank’s statement that “inflation remains too high, continued progress toward lowering inflation is not guaranteed, and the path forward is uncertain.”

The good news is that, Powell said, “interest rates will be at their peak during the tightening cycle,” adding, “If the economy develops broadly as expected, it may be appropriate to ease policy curbs at some point this year.”

But it probably won’t be at the next meeting in March.

“Based on today’s meeting, I don’t think it’s likely that the committee will reach a level of confidence by the March meeting where they can confirm that March is the time to do that (rate reduction). That remains to be seen,” Powell said at a news conference.

He added that March “is probably not the most likely case or what we would call the base case.”

Unreasonable expectations?

Markets appear to have overreacted to the Fed’s decision and comments on Wednesday. In any case, the interest rate cut in March would not have been planned. At its last meeting in December, the Fed spelled out as much as the consensus calls for about three rate cuts in 2024 in its outlook summary, or dot chart. Those cuts are unlikely to begin as early as March.

All three major markets opened higher on Thursday morning, perhaps signaling a collective acknowledgment that things went too far in the opposite direction on Wednesday.

Thursday will be another big day for the markets as three of the Magnificent 7 stocks are all scheduled to announce releases: Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), and Meta Platforms (NASDAQ:META). Especially after business hours. Latest earnings results after market close.