The stock sell-off on Wall Street was “healthy,” as the Federal Reserve’s cautionary projection on future rate cuts gives investors a “reality check,” according to Jeremy Siegel, professor emeritus of finance at University of Pennsylvania’s Wharton School.
The U.S. Federal Reserve cut interest rates by a quarter percentage point at its last meeting of the year, taking its overnight borrowing rate to a target range of 4.25% to 4.5%. Meanwhile, the Federal Open Market Committee indicated it probably will only lower rates twice more in 2025, fewer than the four cuts indicated in its September forecast.
All three major indexes on Wall Street sank in response to the revised Fed outlook, as investors had been betting on the central bank to stay more aggressive in lowering borrowing costs.
“The market [had been] in almost a runaway situation… and this brought them to reality that we are just not going to get as low interest rates” as investors were betting on when the Fed started its easing cycle, Siegel told CNBC’s “Squawk Box Asia.”
“The market was overly optimistic…so I am not surprised at the sell-off,” Siegel said, adding that he expects the Fed to pare back the number of rate cuts next year, with just one or two reductions.
There is also “a chance of no cut” next year, he said, as the FOMC raised its inflation forecast going forward.
The new Fed’s projections show officials expect the personal consumption expenditures price index, excluding food and energy costs, or core PCE, to remain elevated at 2.5% through 2025, still significantly higher than the central bank’s 2% target.
Siegel suggested that some FOMC officials may have factored in the inflationary impacts from potential tariffs. President-elect Donald Trump has vowed to implement additional tariffs on China, Canada and Mexico on day one of his presidency.
But the actual tariffs may not be “anywhere as large as the market fears,” Siegel said, given that Trump would likely look to avoid any pushback from the stock market.
Market participants now expect the Fed to not cut rates until its June gathering, pricing in a 43.7% chance of a 25 basis-points cut at that time, according to the CME’s FedWatch tool.
Marc Giannoni, Barclays chief U.S. economist, maintained the bank’s baseline projection of only two 25-basis-point rate cuts by Fed next year, in March and June, while fully incorporating the effects of tariff increases.
Giannoni said he expects the FOMC to resume incremental rate cuts around mid-2026, after tariff-led inflation pressures dissipate.
Data out earlier this week showed U.S. inflation rose at a faster annual pace in November, with the consumer price index showing a 12-month inflation rate of 2.7% after increasing 0.3% on the month. Excluding volatile food and energy prices, the core consumer price index rose 3.3% on a year-on-year basis in November.
“It is a realization and a surprise to everyone, including the Fed, that given how high short-term rates have been relative to inflation, that the economy can remain as strong as it is,” Siegel added.
The Fed has entered a new phase of monetary policy — the pause phase, said Jack McIntyre, portfolio manager at Brandywine Global, adding that “the longer it persists, the more likely the markets will have to equally price a rate hike versus a rate cut.”
“Policy uncertainty will make for more volatile financial markets in 2025,” he added.