Stocks Sink as Fed Signals Fewer Cuts 12/18/24

0:02Live from the Nasdaq market site in the heart of New York City's Times Square this is fast money Here's what's on tap tonight. Stocks sell off and yield spike after the Fed signals fewer cuts are coming. The Dow now down 10 days in a row. Small caps get whacked. The air coming out of the momentum names in a big way. Look at the moves in Tesla, MicroStrategy, Bitcoin, even the recently red-hot Broadcom. Is this the start of a turbulent end to the year? Plus, Micronauts on the move after earnings. Merck makes a deal in the obesity pill space, and financials hit two-month lows. The details behind all those moves.

0:32I'm Melissa Lee coming to you live from Studio B at the NASDAQ. On the desk tonight, Karen Feinerman, Dan Nathan, Courtney Garcia, and Michael Cantopoulos, Director of Fixed Income at Richard Bernstein Advisors. And we start off, of course, with the Fed decision that sent markets reeling today. The Dow is sinking more than 1 ,000 points, logging its longest losing streak since 1974. The S &P down nearly 3 percent, and the Nasdaq dropping more than 3.5. The small cap Russell 2000 leading the losses in the worst day since June of 2022. This after the central bank lowered its benchmark lending rate by 25 basis points and indicated there could be just two more rate cuts next year, down from the previous forecast of four.

1:09The 10-year yield topping 4.5 % for the first time since the end of May. Meantime, the dollar index closing at its highest level in more than two years. Gold prices pulling back a third of a percent. And the volatility index crossing above 23, the highest reading since August. And some wind coming out of the sales of top performers since the election. Bitcoin down over 5%, while other momentum trades saw steep losses. Tesla, for instance, down more than 8 percent. MicroStrategy sank 9.5 percent. For more on all this, let's bring in senior economics reporter Steve Leisman. Hawkish pause. Hawkish, hawkish.

1:45Yeah, hawkish pause. I talked about that yesterday and the day before, and nobody wanted to believe it. The Federal Reserve cutting rates is expected by a quarter point to a new range of 4.25 to 4.5 percent, but offered a more hawkish outlook on future rate cuts that really spooked markets into doubting just how many more cuts could be on the way in 2025. I think from this point forward, you know, it's appropriate to move cautiously and look for progress on inflation. So how did the Fed freak out markets? Well, the forecast only two cuts next year, not three, as many in the market assumed. There was one descent, but three others in the dot plot without a vote wanted no rate cut.

2:24Four banks that could be the same but are probably not the same did not ask for a discount rate cut, a sign of what their boards and maybe their president wanted, and they raised their inflation outlook for 24, 25, and 26. In addition, several Fed policymakers appear to have begun the process of incorporating potential fiscal policy changes into their forecast from the incoming Trump administration. That could explain why average inflation forecasts went up for 2025 with specific concern about tariffs. Powell said those threats introduced uncertainty into the inflation outlook. Well, what happened to the probabilities?

2:59January, that is out. March, in doubt. May, getting more likely to get that next cut. June, more solidly. But look at that December second cut. The market has not really priced in a second rate cut for 2025. You can see that more clearly. Look at that doubt by the December 2025 Fed Funds futures contract trading around 4 % with a big rise today. It shows little conviction in that second cut that would send the funds rate below 4%. The situation could change if you get better inflation numbers or weaker unemployment data. That could make those cuts more likely. And perhaps even, Melissa, some clarity on what President-elect Trump plans to do with tariffs.

3:41I would also offer about half of, more than half of the post-election Trump bump in equities is now gone. That's a good point there. The situation could change, Steve, if inflation numbers come in better. They could also change if inflation numbers come in worse. And moving to two seems like it's allowing themselves sort of the leeway to reevaluate. So I'm wondering if there was anything in the Fed's language, because they also said the economy is performing very, very well, using two varies in the press conference. I mean, all these things add up to me, like there's the door open to a prolonged pause, much longer, or maybe even a hike possibility down the road?

4:20I think that's right. I don't think, well, look, it's important to point out that Powell also said the Fed is meaningfully restrictive still at this level. That tells you there is some tolerance for inflation remaining where it is or going a little higher before the Fed gets around to doing what you're talking about, Melissa, and hiking rates. There's some tolerance in there. Nobody really knows how much. But if the committee becomes convinced that inflation is no longer headed or no longer has confidence that inflation is headed to 2%, I believe they will hike rates. But the question becomes how and when they incorporate the incoming fiscal policies from the administration.

5:01Steve, it's Karen. Thanks for being on today. I was a little surprised the magnitude of the 10-year move in light of what I thought was somewhat clearly hawkish, hawkish, hawkish from Powell that, you know, since the 10-year was sort of, this 10-year was reflecting concern about, you know, would we just have wild growth and inflation and that this, I would think, would maybe conversely have sort of this hawkishness would have actually given a little more support to the tenure than I thought, or is it just inflation could be high and that's what it's about? I think that's part of it. You know, I'm informed a little bit by Scott Wapner's interview with Jeff Gundlach, who talked about the idea that you really can't make a strong bet on rates going down anymore.

5:50I think from, let's call it the summer, maybe a little earlier, through the fall, you could say, all right, I'm going to take a position on rates coming down, and it was a pretty secure position. I'm not sure you can take that anymore. Where would you put rates? It may be that we're at the top end here in terms of where the 10-year is. I agree with you that it would think that given that hawkishness, the Fed was going to be leaning further and more strongly on inflation in the coming year than it otherwise had been. But I also think, you know, Melissa's question is not an idle one. She has her finger on the market as good as anybody.

6:23And if she's asking Steve, are rates going to possibly go up next year? Well, it must be a salient risk, I would say. I don't know. Well, let's ask Michael Cantopoulos, who's on the desk tonight, fortunately. What do you think? Because, I mean, just yesterday or the day before we were talking about T. Rowe Price, they're had a fixed income saying 6 % next year. Yeah, I don't know if we'll get to 6 % next year. I mean, maybe over the course of the next economic cycle. I guess if it's the start of a new economic cycle, then certainly we could get there. But listen, in what world is the Fed restrictive?

6:56I just don't see how that could even be uttered with a straight face. I mean, they're looking at some hypothetical neutral rate. They're looking at the real Fed funds rate and saying, oh, we're restrictive. But remember, the transmission mechanism of interest rates is to affect lending. Lending standards are easing. Credit spreads are at all time tight. You got speculation in markets and Bitcoin. You know, banks are easing lending standards. There's plenty of liquidity out there. The effect of rates has not filtered through to the economy, obviously. So I would argue that they're not restrictive.

7:26I agree with the sentiment about the 10-year. You know, you would think that if you're going to tame long-term inflation and growth expectations, the 10-year should stabilize, not go up. But I think this is much, you know, more to do with a knee-jerk reaction than anything else. And I wouldn't take too much out of today's price action. I think we have to see how that plays out over the coming days before really understanding how the market takes this. Steve, I'm curious, when Powell was talking about the 2 % number, he said effectively that they're committed still to 2%, but it may take much longer than we were expecting.

7:58It may take another year or so. Does that jive with what he said in the past, or is that a longer time frame? Is that inflation fight going to be more protracted than we think? I had the same thought when he said that. Is that showing us that he has more tolerance for inflation running above target than he previously did? I think the thinking here is that it's not broke in the extent that you have unemployment relatively low, relatively contained. The job market is a little bit looser. And it's not, as he said several times, a threat to the inflation story here. And so I think what he's saying is, at this point, given that growth has been pretty good, given that unemployment's been pretty well behaved, I'll take a little more time and not try to break it in terms of pressing further on the economy.

8:48I think that's what he's saying right there. But I think what was said by the previous guest there was really fascinating. This idea that the market doesn't necessarily believe that the Fed is restrictive here and therefore going to have a positive effect in terms of bringing down inflation. This is a big issue here worth debating. If you think the Fed is restrictive and going to win this inflation battle, you can bank on more rate cuts. If you don't think that, as the previous guest does not, then you cannot take that stand on more rate cuts coming next year. Steve, thank you. Steve Leisman from Washington for us.

9:28So where do you stand on that point, Dan? Yeah. Listen, he's the smart bond guy. I'll talk about the stock market. I'm kind of the dumb stock market guy, too. So go back to late 21. I think we can all agree there was clearly a stock market bubble, right? And we had this crazy period of late 2020, 2021. Everything that wasn't bolted down was going up. Fed funds was basically on a zero interest rate bound. The 10-year was about 2 % or so. So it was doing okay, right? And so relative to Fed funds. Well, what happened? When the Fed signaled that they're going to start raising interest rates, right, to battle inflation, these tech stocks got killed, right?

10:04The NASDAQ went down 38 % over the next year, right? So I think about what's going on right now. Now, if you are kind of taking off the table further cuts or, you know, three, four, like a lot of folks were kind of expecting in 2025, then you have to start thinking about valuations. You have to start thinking about this dollar that has gone from 100 to 108. That's the U.S. dollar index, the Dixie. And you have to say to yourself, all these stocks that have pulled forward so much performance, right, they're anticipating double digit earnings growth in 2025. Now they have serious headwinds. We were talking about that yesterday, right?

10:36We're talking about the dollar. We were talking about where yields are and where they're likely to go. Yesterday, we were 4.4. Today, we're 4.5. If they go to 5%, if you don't think that the NASDAQ and the S &P have a down 20 % move from here at some point, I think you're not doing this correctly. So to me, I think Faxed has about 15 % expected EPS growth in 2025. If the dollar stays here, if yields stay here, that's not happening. I think the one thing we also have to think about is why rates might not be coming down, right? Because I think it's interesting you're seeing this, Michael, you brought up a good point, a knee-jerk reaction.

11:10I think that's exactly what you're seeing today because the bond markets have been pricing this in. I think we all knew that the Fed was going to have to either start pausing here or cutting less than they were expected to. But if they're not cutting because the economy is strong and prices are still stable, that's very different than them having to cut one or two more times next year because they need to save the economy. And if you're in that position where the economy can continue to grow, unemployment stays low at these higher rates, I don't think that's a problem for a lot of the equity markets in general.

11:36You're seeing this knee-jerk reaction specifically on some of your rate-sensitive sectors. So things like real estate, things like small cap are clearly playing off today. But inflation is going to be a concern next year. So you want to have those inflation hedges in there because that could be a problem, but you want to make sure you balance it out. So in that scenario that you laid out, Courtney, does that mean that these dips in some of these high-flying names, I mean, do you go in and buy big cap technology? I mean, I think that's what, I don't want to boil it down so simply, but I'm sure a lot of people at home are thinking, you know what?

12:02Nasdaq down 3%, 3.5%. Is this my chance to get into an NVIDIA? Is this my chance to get into Bitcoin? I think what you have to look at, too, is even though this is how to dip, these are still doing so well since the beginning of the year. So when we look at our clients, most people are still way overexposed to these. We've been trying to get people to take some profits off the table. Even with this dip, that's still the case. So is it buying profit? Probably. But most people I was there are still overexposed to it. So I think that's something you need to balance out. Without being a little bit cliche in sort of the tale of two markets next year, I mean, you could easily see a scenario where you go into next year, Profit growth is reasonably strong.

12:34You know, this this rise in rates ends up in the sell off in stocks gets washed out because of the strong growth environment, all the promise of, you know, the fiscal policy that might be coming under Trump, et cetera, only to see earnings growth start to slow as you get later into the second quarter, into third quarter. and at the same time, restrictive policy, right, start to bite a little bit. And that way, to Dan's point, it is very reminiscent of 2022. Just rather than runaway inflation, you have higher than average inflation. Instead of, you know, an earnings recession, you have slower earnings growth.

13:07Instead of a Fed that's hiking, you have a Fed that's pausing, all coming off of elevated equity levels and tight spread levels. That does not bode well, I think, for back half of 2025. But near term, I think the signaling is actually reasonably strong. I think the pullback in banks is actually really interesting. I don't think that the environment for banks, the backdrop for banks, which I view is very positive. Yeah. Right. I think you've got you've got growth in loans because I do think the animal spirits are still there. I think you've got great potential for M &A, good capital markets, and they're not crazy expensive.

13:44And so this pullback, I think, is attractive. I would be adding. Yeah, I just had one other thing, and I know we don't price in geopolitical risk, but if I look around the world, I cannot remember the last time there's been so much uncertainty. Look at what's going on in Canada right near us. Look at what's going on in Germany. Look what's going on in France. Look what's going on in Russia and Ukraine. Look what's going on in Syria and the Middle East. Look what's going on in China and Taiwan. And that's not just the only point I want to make here. China's economy is a disaster. Okay, when you think about this, we have disinflation here, and they're worried about a reflation, right, of that.

14:18But look at what's going on there. They might be like they might export deflation to all the points around the world. That is not helpful to us one way or another. And if you think about this dollar, it's going to continue to go higher under that scenario. So I just think this is a really messy year. And then you think about what we learned about President-elect Trump's first admin. There's just going to be so much rhetoric that moves around. CEOs don't like that sort of uncertainty, especially when things are going great here. Fine. If we have to worry about tariffs and then we have to worry about weakness all around the world and a strong dollar, that just doesn't set up for a great scenario that gets you to 15 percent year over year earnings growth, in my opinion.

14:56For more on today's decision, let's bring in former Cleveland Fed president and CEO Loretta Mester. She's also a CNBC contributor. Loretta, great to see you. Nice to see you. What was your take of Jay Powell's press conference, his forward guidance specifically? Yeah, I mean, I think it played out exactly as expected. I mean, I think coming into this, it was clear that the Fed should be thinking about pausing. And I think he made it clear that that's what's on their mind. The dot plot showed half as much reductions next year as the former dot plot did, which is exactly right. I thought something significant he said was that they have reduced the degree of restrictiveness quite a bit.

15:37And I think that's important because I think that's kind of where their mindset is. So you think about what they were doing since September's recalibration. Now, going forward, this is really about balancing those risks, making sure that they keep the funds rate at an appropriate place so that no matter how those uncertainties that you've just been talking about play out, they're in a good position to address them, either by holding at that current rate for much longer than anticipated, or if things on the employment part of the mandate weaken more than they expect than bringing the rate down faster.

16:14So I think they're still in a good position here. I think the markets are reacting in a way that's kind of interesting because this was, I think, pretty well expected. But maybe it emphasizes that there is still a lot of uncertainty out there about the economy for next year, including what fiscal policy actions we're going to see. Loretta, it's Karen. Thanks so much for being on. Given how hawkish he was and how he had statements like, you know, more cautious in the future, that sort of thing, and kind of the reluctance to even make this cut, can you explain how did it happen that it actually did cut, even though the market seemed to be forcing them to not?

16:54What goes on in the room that makes them come to this conclusion? Yeah, so I think, you know, going into this meeting, I'm sure there There were a lot of people who came in saying, you know, I could see it going either way. You come in sort of with your formulated view. They did nothing in the intermeeting period to really persuade people that a pause was likely to happen at this meeting. And more importantly, why go forward with it? Well, the narrative surrounding the economy hasn't changed. If you look at the projections and what Chair Powell said at the press conference is they still expect inflation to come down toward 2 percent over their forecast horizon.

17:36It won't get all the way to 2 percent, but they expect it to be moving down. And they still expect, right, the labor market to remain healthy. Yeah, tick up in the unemployment rate over time, but still a healthy labor market. It's just going to take a different policy path to get those outcomes. So it will take probably more restrictive policy, certainly more restrictive than they thought in September. And that would be the reason you could go forward with the rate cut of 25 basis points, as long as you coupled it with the information that they gave us in the communication, which was, look, from here on out, we're really going to be thinking about each meeting and looking at the cumulative information.

18:18So the way I think about it is over this period where they were recalibrating, coming into the meeting, it was, is the evidence, start with a base case, we're going to be cutting. And now what's the evidence that would sort of say go against that? From now on, I think coming into the meeting is we're not cutting at this meeting. What's the evidence? What's the accumulated evidence that says, okay, we can resume those cuts? That's how I would be thinking about it now. So it's basically a subtle change of, you know, what's the base case going into a meeting? And then what does the accumulated evidence tell you?

18:53Okay, is it time to resume? We can bring it down another notch because inflation has resumed coming down and we think it's on that path towards two? Or, right, is it now we still haven't seen the progress on inflation? And so we're going to hold pat for another meeting. And that's how I think about it. So it's a subtle change in sort of what the base case is going into a meeting. The overall forecast remains the same, that eventually they'll be moving rates down because the economy is going to get back to 2 percent inflation. Loretta, Mike Cantopoulos here. I mentioned earlier that the transmission mechanism of higher federal funds rate is through credit channels.

19:33And what you ultimately want to do is either slow or speed up the availability of credit. And that's really sort of how interest rate policy works. So when you look at credit channels out there, I'd still argue they're incredibly easy and actually getting easier. Bank lending standards, credit spreads, et cetera. So, you know, I know the real Fed funds rate is elevated, and I understand that we're above some theoretical neutral rate. But does anybody actually sit in the room and talk about the impact of higher rates and how it's affecting credit availability? Or is that just, you know, assume that it's going to at some point or another?

20:05No, I mean, they talk about that in the room, and certainly we did when I was there. We looked at the overall set of financial conditions, and of course, the Fed produces its own indices of these things. But on the other side of that, if you think about how many people have and households have low-rate fixed-rate mortgages, that's something that works against the transmission of lower rates into the economy. So again, it depends on what sector you're looking at, whether the transmission mechanism is the typical one or not. And I think the way the chair likes to put it is he looks at sort of what's happening on both sides of the mandate.

20:46And if you look at the employment part of the mandate, you have seen some moderation on the employment side. So that's and you have seen inflation come down on the inflation part of the mandate. And so that would be an indication that policy is restrictive from the point of view of what the Fed controls. and therefore, you know, we're getting back to, you know, price stability and full employment. But I think the real key thing is there's risk around that. And one of the risks you're pointing out is that perhaps financial conditions aren't as tight. And that manifests itself today in looking at what the Fed participants think the long run Fed funds rate.

21:24It's not exactly, you know, what a neutral rate would be at any point in time. But over the long run, the Fed funds rate has moved up in those projections. And in fact, one thing I noticed in the SEP today, which I found very interesting, is that over the forecast horizon, even by 2027, the Fed funds rate they're projecting is above, still restrictive relative to the long-run Fed funds rate. That wasn't true in the September SEP. So again, they are projecting that they're going to have to remain more restrictive than they thought and over the full forecast horizon. Loretta, always great to get your take, especially on a day like today.

22:06Thank you. Thanks, Melissa. Happy holidays. Loretta Mester, happy holidays to you. So, Karen, your view of the markets for 2025 yesterday versus today, has it changed? No, not really. No. I mean, we're back, I don't know, 10 days ago. Some things are down more. No, no. But higher. I mean, this is this is sort of like higher for longer. I didn't think I was not thinking there would be many multiple cuts. Oh, OK. So you weren't you weren't in that camp. I'm short the tenure. Right. So I you know, because I think we'll see inflation. So, no, nothing really changed. Yeah. How about you? Yeah, I'd agree with that.

22:43I mean, I think if you're if you're watching what's happening, the expectation was that the Fed was probably starting to get ahead of themselves. and this was likely going to happen. So I don't think this should change your bigger picture. I think one thing that probably changes is the fact that all that cash that's sitting there, it's probably going to sit there longer because if people think, oh, I'm still going to get over 4 % of my money markets, why do anything with it? So I think that part of the markets probably stays where it is. It doesn't start to funnel its way in. I don't think that's a bad thing for the markets, but that's one less catalyst upwards.

23:09Yeah, so what changed for me is just like to see how quickly investors sold the fateful eight. And that's really the most important point. Which are the biggest eight stocks. Oh, yeah, the$8 trillion stock. You haven't heard that yet, Michael? I've heard it. Okay, just coinless. I'm a Bond guy. I still hear these things. But I think that's what's really important. And the other thing, and you know I've been in this camp, that I think that there's going to be this period next year where there's overcapacity and a lot of stuff that CapEx has been spending on. And I think just the fact that you're going to see a deceleration in the CapEx, Microsoft's been telling you that.

23:38The numbers in Microsoft have basically been notching lower a little bit. Satya Nadella and Dan Niles pointed this out, was on Brad Gerstner's podcast last week. He said he is not constrained on chips anymore. What does that mean? It means their CapEx is going lower. OK, so he's constrained on power, but that's also been a bubble. So what's clear to me is that the generative AI bubble, there's some air coming out of it. It just depends how far you think it could go. And the only thing I'll just finish on is like we've seen a pull forward in a lot of the excitement about the activity that's going on.