Expectations of Fed cuts were the death blow to the markets

On By Littum

Traders work on the New York Stock Exchange (NYSE) floor in New York City.

Spencer Platt | Getty Images

This report is from today’s CNBC Daily Open, our international markets newsletter. CNBC Daily Open brings investors up to speed on everything they need to know, wherever they are. Do you like what you see? You can subscribe here.

What you need to know today

A cut now, but fewer ahead
The US Federal Reserve cut rates by 25 basis points on Wednesday, bringing its overnight borrowing rate to a target range of 4.25%-4.5%. In the Fed’s dot plot indicating expectations for interest rates in the coming years, the central bank mostly indicated just two rate cuts for 2025, fewer than the four cuts previously forecast in September.

Sharp sell-off in the markets
US markets sold off sharply from Wednesday. The Dow Jones Industrial Average lost more than 1,000 points, falling 2.58% for its 10th consecutive day of losses. The S&P 500 withdrew 2.95% and the Nasdaq Composite decreased by 3.56 per cent. The pan-European Stoxx 600 — which ended trading before the Fed’s decision — added 0.15%.

Shares in Tesla are making a comeback
Tesla shares fell 8.3% on Wednesday, their steepest drop since Donald Trump won the US presidential election in November, amid heavy losses in the broader market. While shares are still up 75% since the Nov. 5 election, the company’s stock appears “widely disconnected … from fundamentals,” Barclay analysts wrote in a report Wednesday.

Disappointing guidance from Micron
Shares of Microns plunged more than 15% in extended trade after the company provided significantly weaker-than-expected guidance, although it beat earnings expectations for its latest quarter. For the current quarter, Micron expects revenue of about $7.9 billion. That’s far less than the $8.98 billion that analysts were expecting, according to LSEG.

(PRO) Why the markets were so disappointed
The stock market took a hit after digesting the Fed’s forecast that monetary policy in 2025 will remain tighter than previously expected. CNBC’s Sarah Min looks at why investors were so disappointed and what market watchers think about the Fed’s decision.

Bottom line

Wednesday’s dramatic sell-off in the markets is a stark reminder that forecasts influence stock movements much more than current circumstances.

The Fed lowered its key interest rate by 25 basis points. Borrowing costs will fall and business investment should be stimulated, which should lead to job creation and increase growth. In turn, this in theory pushes the shares up.

But investors were already convinced of the Fed’s tapering on Wednesday. Ahead of the end of the Fed’s December meeting, the futures market indicated a 98% chance of a 25 basis point cut, according to CME FedWatch Tool. This means that investors had already priced the benefits of the interest rate cut into shares. In other words, yesterday’s cut would have little effect on share prices. Investors perhaps praised even more optimism than the single interest rate cut. Just a day ago, investors were betting on an 81.6% chance that the Fed would cut interest rates by another 25 basis points in January.

Fed Chairman Jerome Powell dashed that hope.

“With today’s action, we have lowered our policy rate by a full percentage point from the peak, and our policy stance is now significantly less restrictive,” Powell said at his press conference after the meeting. “We may therefore be more cautious when considering further adjustments to our policy rate.”

The possibility of a 25 basis point cut next month evaporated to just 6.4% according to the futures market after the Fed released its updated dot plot indicating just two cuts for 2025.

It’s this massive paradigm shift—from hopes that the Fed will go full throttle with cuts to the reality that it might even take its foot off the accelerator—that is sending tremors through the markets.

To put it another way: It’s like waking up expecting a present on Christmas Day, only to find yourself bereft of presents. That disappointment wouldn’t happen at any other time of the year.

As David Russell, global head of market strategy at TradeStation, gloomily noted: “Goodbye punch bowl. No Christmas cheer from the Fed.”

— CNBC’s Daria Mercado, Jeff Cox, Yun Li, Brian Evans and Lisa Kailai Han contributed to this report.