As the year came to a close, December brought a recalibration of investor expectations, primarily driven by the Fed’s quarter point rate cut around mid-month. Stock had rallied the prior month as many planned for a more favorable corporate tax policy under the incoming Trump administration. However, this petered out when the Fed took a more cautious outlook due to strong economic conditions coupled with slightly elevated inflation.

Interest rate cuts

The Fed initiated two 0.25% interest rate cuts during the quarter. This reduced the target overnight borrowing rate to 4.25% - 4.50%, down 1% since before the first cut in September. While the two cuts roughly matched expectations, Fed Chair Jerome Powell’s uncertain 2025 outlook did not. Expectations among Fed members are now for 0.5% in additional cuts in 2025, down from 1% before the December meeting.

While equity investors may be disappointed with the outlook for fewer rate cuts next year, there may be some positives. If rates do settle in the 4% range, it preserves some flexibility for the Fed if the economy slows. It also allows for reasonable income streams for conservative investors with high bond allocations. The yield curve is again upward sloping, which is typically considered better for liquidity and overall growth.

Stock market slips

The total U.S. stock market fell roughly 3% in December, with a sharp intraday sell-off immediately following the Fed’s meeting. Rate sensitive categories such as real estate and small cap stocks were hit particularly hard. Emerging market stocks fared a bit better, but also finished the month down along with most major asset classes.