https://www.morningstar.com/markets/how-feds-surprise-outlook-adds-market-uncertainty-2025-2
Ivanna Hampton: Welcome to Investing Insights. I’m your host, Ivanna Hampton.
Many investors’ expectations rose in 2024. Factors like the broader stock market rally and the artificial intelligence boom lifted moods. But the feeling of uncertainty is inching up for 2025 because of stubborn inflation and the new administration in Washington. Some market watchers are asking what’s next.
I talked with Morningstar Inc.'s global markets editor Tom Lauricella about 2024’s biggest headlines. The “Smart Investor” newsletter editor also shared five storylines that investors should watch for in 2025.
Hampton: The Federal Reserve’s interest-rate forecast for 2025 overshadowed its final rate decision for 2024. The Fed trimmed a quarter point. How did Fed Chair Jerome Powell explain the committee’s decision to scale back from four cuts to two next year?
Lauricella: What we saw was a very interesting shift, and I just want to say what was most notable was that this was the first real surprise that we’ve seen out of the Fed in quite some time. The Fed’s become very, very good at signaling what it’s going to be doing. They don’t like to surprise the markets. I’m hard-pressed to think of a meeting lately where we didn’t know exactly what they were going to do, or even to the degree to which Powell was going to be signaling what he was actually going to be saying. We’re used to seeing comments coming out from Fed officials before the meetings that foreshadow, and usually these meetings are a pretty significant nonevent for the markets.
So we didn’t have that at this final meeting of the year. And in fact, it was pretty surprising, I think, to a lot of investors the degree to which the Fed was very, very much pulling back on their guidance for interest-rate cuts in 2025 and also the way this came about. Not only did Fed officials pare back their forecasts, but they made it clear that they’re not really sure what’s going to be happening next year, in part, and they cited policies in particular. We have an economic backdrop where the economy’s healthy, inflation is still a little bit above their target, although it’s better than it was. Ordinarily, people thought that that would give the Fed room to keep lowering rates, but it’s clear that the Fed is being very cautious about its own outlook, and that really surprised the markets. That’s why we saw a big move in the bond and stock markets. We’ll see how it plays out over coming weeks. But it was a pretty notable Fed meeting for a change.
Hampton: Yeah. And that surprise did seem to rattle the market yesterday. Now, we’re recording this episode the following morning. How’s the market looking now?
Lauricella: Well, things have stabilized. I think people are digesting after the knee-jerk reaction, but if the Fed is only going to cut rates twice next year, and there’s even a little bit of chatter about whether the Fed will end up having to raise rates before we get out of 2025, that’s a pretty significant difference in the outlook that people have to process. And of course, these expectations tend to move back and forth quite a lot. If you track them over the course of the year, they change a lot. We could get into 2025 and it could be a very different outlook, but for now, people are saying, “OK, it seems like there’s a lot of uncertainty in terms of the Fed’s own outlook here, but what they’re telling us is don’t expect the big rate cuts that most people had been expecting.”
Hampton: Now, what else did you find significant about the Fed’s economic outlook?
Lauricella: What was interesting, and Preston Caldwell noted this, that the Fed is not seeing a significantly stronger economy next year. So they’re not pulling back on rate cuts because they think the economy is too hot. Their inflation forecast is not as optimistic as it was, and that’s perhaps part of the big reason. But really it’s more in the wording and their hesitancy to be cutting rates as aggressively as people had thought, which leaves us at interest rates at much higher levels than we had, say, prepandemic, that’s for sure.
Hampton: President-elect Donald Trump has proposed imposing tariffs on multiple countries, including China. There are concerns that tariffs could reheat inflation. How does Morningstar view this?
Lauricella: The first thing is our economists, like everybody else, we don’t really know what’s going to happen. Forecasting is a very difficult art, even when you think you know what’s going to happen. This debate over tariffs is going to be a significant fight. If you take the president-elect at his word, virtually every economist under the sun has said that it would be a negative for inflation – inflation would go up – it would hurt growth. There are other policies in place that could also potentially hurt economic growth, such as the deportation of immigrants, illegal immigrants. That’s been a big source of job growth in this country. There’s a significant economic uncertainty right now. We’re going to have to see what actually happens because who knows in Washington right now, but it’s really hard to tell at this point.
Hampton: Now, the stock market is flying high because of the AI boom, the broader stock market rally, and more. Could this momentum carry into 2025?
Lauricella: We’re ending the year on a little bit of a less optimistic note than it seemed just a few weeks ago. On the AI front, Morningstar analysts are very optimistic about the potential for AI technologies to continue to fuel a lot of profit growth in the key technology companies. There are concerns about valuations. There are some aspects of the market that are getting a little bit frothy. But as far as AI is concerned, we see this as an important trend that will continue to drive profit growth for years to come.
But the broader sentiment, perhaps investors in the stock market are finally coming around to what the bond market has been saying, which is that, “hang on, it may not be such an accommodative environment going forward,” which could take the wind out of sails a little bit. The common refrain around Wall Street is: We’ve had two massive years of gains in the stock market, probably have a good year next year, but don’t expect these gains approaching 30% like we were seeing.
Hampton: The bond market has not performed as well as the stock market this year, but there’s a positive story here. What is it, Tom?
Lauricella: Yeah, the positive story is that, for investors, yields in the bond market are very attractive right now. Investors were so yield-starved for years and years before the pandemic and coming out of it. That all changed when the Fed aggressively raised interest rates. At this point, yields have come down some, but given the concerns that we’ve seen about inflation staying high and growth staying strong, yields have not come down that, that much. So you can still get an attractive yield above inflation in the bond market. And so that’s good for savers.
Hampton: And bitcoin recently hit a milestone: It surpassed the $100,000 mark, when a few years ago it sat below $20,000. Talk about what it means for a crypto-friendly administration to enter the White House.
Lauricella: Yeah. Well, the crypto market is a funny one. It’s hard to say what drives it aside from sentiment. At this point, what we’ve seen is bitcoin and other cryptocurrencies rallying on this idea that there’ll be more-friendly regulators in place. That could very well be the case. Does it mean that bitcoin continues to rally? Who knows? It’s a very sentiment-driven market at this point. Crypto bulls are bullish. Crypto bears are bearish. And that’s one that I think we don’t want to try and make any forecasts.
Hampton: Gotcha. As President-elect Trump prepares for a second term, is there a blueprint from his first term for investors?
Lauricella: I think we’re starting to see the blueprint, as we saw a lot during the first term, which is policymaking by tweet, or whatever it’s called these days on the X platform, with the added complication for investors now that we seem to be getting policy pronouncements out of Elon Musk. So I think the main thing for investors at this point is be braced for a lot of volatility, be braced for a lot of statements back and forth, pronouncements that may or may not ever become policy. It’s going to be a very challenging environment. We saw that in the first term. We’re likely to see that in the second term. So in terms of blueprint, expect that kind of dynamic.
Hampton: And what are five storylines you think investors should watch for in 2025? I got my pen and paper. I’m ready.
Lauricella: The first I think we’ll stick with Washington. I think Washington policymaking at the fiscal level, at the regulatory level is looking to be a lot more of a key variable as we go forward in 2025 and beyond at this point. We’re seeing just everything from what’s this going to mean for the EV market to budget deficits and taxes. This is going to be a significant question and theme as we go forward.
The second, of course, the Fed and Fed policy, we’re seeing a little bit of an intersection between the Fed and what’s happening, like I said, in terms of Washington policies, most notably tariffs. How will the Fed be reacting? How will that continue to play out? It’s always an important story, but I think that will stay on the front page as it were.
Related to that, what’s going to happen in the bond market, will bond yields stay high? That’s an important variable for investors. If bond yields are remaining at these kinds of attractive levels, in some ways they offer a competition for the equity market. That could change people’s view on stocks if other factors start to go against the stock market.
The fourth one, I would come back to AI and how that continues to play out. These AI stocks like Nvidia, Microsoft, they’re all such heavyweights in the market that we can’t ignore this story. It’s possible to have negative fundamentals elsewhere, and yet Nvidia continues to crank out massive profits, and that can have a significant impact on the overall stock market. So that’ll be a key one to watch as we go forward.
And the last one, I’m going to throw out a little bit of a different one, which is the IPO market. There was a big IPO just a week ago. There’s some thought that, if the market environment stays friendly, that we’ll start to see things loosening up there. The IPO market’s been very, very quiet. Depending on how the stock market goes, if things stay friendly, we might actually start to see some interesting names come to market, but we’ll have to watch the market backdrop for that one.
Hampton: That wraps up this week’s episode. Investing Insights is going on winter break. We’ll return with a new episode on Friday, Jan. 3, 2025! Check out Morningstar’s YouTube channel for new videos while we’re away. Thanks to Senior Video Producer Jake VanKersen and Associate Multimedia Editor Jessica Bebel. I’m Ivanna Hampton, lead multimedia editor at Morningstar. Happy holidays!
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