Is the Fed’s Pause Setting the Stage for More Stock Market Turmoil?

Did the Fed Just Open the Door to More Market Volatility?

The Federal Reserve’s recent decision to pause rate cuts has introduced fresh uncertainty for investors, shifting focus to inflation data and the potential for rate hikes in 2025. This development has already led to increased market volatility, as evidenced by a significant spike in the Cboe Volatility Index (VIX).

Why Is Inflation the Key Concern?

The Fed’s latest projections indicate that core personal consumption expenditures (PCE), excluding food and energy, are expected to remain elevated at 2.5% through 2025, surpassing the central bank’s 2% target. Additionally, November’s core Consumer Price Index (CPI) rose by 3.3% year-over-year, highlighting persistent inflationary pressures.

Compounding these concerns are potential tariff increases proposed by President-elect Donald Trump, targeting major trading partners such as China, Canada, and Mexico. While some analysts, like Jeremy Siegel, suggest these tariffs may be less severe than feared, any resulting inflation could delay the Fed’s anticipated rate cuts.

How Are Markets Responding?

Investor sentiment has shifted notably. The CME FedWatch tool now indicates a 43.7% probability of a 25-basis-point rate cut in June 2025, reflecting tempered expectations. Barclays projects only two 25-basis-point cuts next year, in March and June, assuming tariff-induced inflation is factored in.

The Fed’s pause has also led to increased market volatility. Following the policy meeting, the VIX—often referred to as the market’s “fear gauge”—spiked by 74% to 27.6, signaling heightened investor anxiety.

This surge in volatility accompanied significant declines in major indices, with the Dow Jones falling 2.6%, the S&P 500 dropping 2.9%, and the Nasdaq decreasing by 3.6%.

Could a Rate Hike Be on the Table?

The resilience of the U.S. economy adds complexity to the Fed’s policy decisions. Despite high short-term rates, economic growth has remained robust, challenging traditional expectations. If inflation persists or accelerates—due to strong economic performance or the implementation of tariffs—the Fed may consider raising rates instead of cutting them.

Outlook: Unsteady Markets Ahead

The Fed’s current stance is likely to contribute to ongoing market volatility. The pause in rate cuts, combined with persistent inflation concerns, leaves traders susceptible to unexpected developments. While the possibility of rate cuts remains, any uptick in inflation could prompt a more hawkish policy response, exerting pressure on markets in 2025.

Investors should remain vigilant, closely monitoring inflation data and preparing for rapid shifts in market sentiment as the Fed’s policy direction evolves.

More Information in our Economic Calendar.