Jeremy Siegel, a professor emeritus of finance at the Wharton School of the University of Pennsylvania, recently provided his insights on the current state of the stock market following the latest actions and projections from the U.S. Federal Reserve. According to Siegel, the recent stock sell-off on Wall Street was a “healthy” response, triggered by the Fed’s cautious stance on interest rates. He emphasized that the market's reaction to the Fed’s latest outlook serves as a necessary “reality check” for investors, who had become overly optimistic about the future path of rate cuts.

Fed’s Revised Projections

In its most recent meeting, the Federal Reserve made significant adjustments to its projections for future rate cuts. While the central bank did reduce interest rates by a quarter percentage point, bringing the overnight borrowing rate to a target range of 4.25% to 4.5%, its outlook for the next year was more conservative than investors had anticipated. The Federal Open Market Committee (FOMC) indicated that it is likely to reduce rates only twice in 2025, down from the four rate cuts projected in its September forecast. This shift in expectations led to a sharp decline in all three major U.S. indexes, as investors had been expecting the Fed to be more aggressive in easing monetary policy.

Siegel’s View on the Sell-Off

Siegel noted that the stock market had been in a nearly “runaway” situation, with investors overly optimistic about the future pace of interest rate reductions. The Fed’s announcement acted as a “reality check”, bringing the market down to earth by clarifying that interest rates would not drop as dramatically as investors had hoped. “The market was overly optimistic,” Siegel remarked, adding that this correction was not unexpected.

Siegel projected that the Fed would only reduce rates once or twice in 2025, and he suggested there is even a possibility that no rate cuts would occur at all, especially given the Fed’s inflation projections.

Inflation Forecast and Tariff Impact

One of the key factors contributing to the Fed's more cautious stance is its revised inflation forecast. The core Personal Consumption Expenditures (PCE) index, which excludes food and energy costs, is expected to remain elevated at 2.5% through 2025, which is still above the central bank’s target of 2%. This suggests that inflationary pressures are likely to persist longer than previously expected.

Siegel also addressed the potential impact of tariffs on the inflation outlook. He pointed to the possibility that President-elect Donald Trump’s plans to implement additional tariffs on countries like China, Canada, and Mexico could exacerbate inflation. However, Siegel believes the actual tariffs may not be as severe as the market fears, as Trump would likely seek to avoid negative market reactions.

Market Expectations for 2025

As a result of the Fed’s cautious projections, market participants are now expecting the central bank to hold off on rate cuts until June 2025, with a 43.7% chance of a 25 basis-point reduction during that meeting, according to the CME’s FedWatch tool.

At the same time, Marc Giannoni, chief U.S. economist at Barclays, maintained that the Fed would likely implement only two rate cuts in 2025—one in March and another in June. Giannoni also highlighted that the effects of tariff increases would play a role in limiting the speed of the Fed’s policy adjustments.

Inflationary Realities and Economic Strength

Siegel pointed out that the surprising resilience of the economy, given how high short-term rates have been in comparison to inflation, underscores an important realization: the U.S. economy remains strong despite elevated rates. This has been a surprise not only to the Fed but also to many market participants.

Recent data also showed that U.S. inflation has been rising at a faster-than-expected pace. The consumer price index (CPI) for November 2024 revealed a year-on-year inflation rate of 2.7%, and the core CPI (excluding volatile food and energy prices) rose 3.3% year-on-year.

Volatility Ahead for Financial Markets

According to Jack McIntyre, a portfolio manager at Brandywine Global, the Fed has entered a new phase of monetary policy—the “pause” phase—and the longer this phase persists, the more likely it is that financial markets will need to price in a rate hike alongside a rate cut. This policy uncertainty is expected to bring increased volatility to the financial markets in 2025, making it more challenging for investors to navigate future market fluctuations.

Conclusion

Overall, Jeremy Siegel’s analysis highlights a critical moment in the U.S. stock market. The recent sell-off is a natural correction after the market’s overly optimistic expectations for future interest rate cuts. With the Fed’s cautious stance and ongoing inflationary pressures, investors will need to reassess their expectations and prepare for potential market volatility in 2025. This shift in expectations marks a turning point in monetary policy, with more uncertainty on the horizon for financial markets.