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Markets Believe The Fed Got It Wrong: Rate Cut Reluctance Rattles Investors

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Technology stocks, consumer goods and small caps faced the steepest downturns after the Federal Reserve dialed back on expectations for interest rate cuts in early 2024.

U.S. equity markets closed sharply lower on Wednesday, following the Fed’s message to markets: don’t expect a rate cut in March.

Although stocks were making something of a recovery on Thursday, on Wednesday the S&P 500 shed 1.6%, the tech-heavy Nasdaq lost 2.2% and the Russell 2000 index of small cap stocks fell 2.5%.

Looking at the highly-popular exchange traded funds that mirror the performances of these indexes, and it was the same story: the SPDR S&P 500 ETF (NYSE:SPY) fell 1.6%, the Invesco QQQ Trust (NYSE:QQQ) lost 2% and the iShares Russell 2000 ETF (NYSE:IWM) shed 2.5%.On Thursday, most indicators, including those from rate and money markets, suggested a decreased likelihood of an interest rate cut in March.

These also included the CME Group’s FedWatch Tool, which showed the probability of a quarter-point rate cut at the Fed’s March meeting is 44.5%, down from 52.8% on Wednesday before the Fed meeting, and down from 73.4% a month ago.

Also Read: Fed Will Wait To See ‘The Whites Of 2% Inflation’s Eyes’ Before Cutting Rates: Economists Weigh In On Powell’s Remarks

March Rate Cut Not Likely

The Fed said a March rate cut was not likely, which poured cold water on the market expectations that drove the powerful fourth-quarter rally.

While this was only a slightly hawkish turn, analysts at Datatrek said the reaction suggests that markets believe the Fed got this call wrong.

Datatrek said: “Given that futures actually increased the odds of rate cuts this year, despite Powell’s comments and U.S. equities sold off by over 1.5%, it seems clear that markets believe the Fed is about to make a policy mistake.”

James Knightley, chief international economist at ING, said the Fed’s delay was because it was afraid of making a policy misstep.

“We suspect that the Fed recognizes its credibility was damaged by its ‘inflation is transitory’ assertion in 2021 only to have to rapidly reverse course with significant rate hikes through 2022 and 2023,” he said.

“The last thing the Fed wants to do is get it wrong again at a key turning point, loosen too soon, too quickly and reignite inflation…

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