Our problem is not markets that are too volatile – It’s traders that are too sensitive

Federal Reserve Chair Jerome Powell shook financial markets this week, delivering a reality check that left traders scrambling.

On Wednesday, Powell laid out a cautious approach to interest-rate cuts for 2025. Stocks nosedived 3%, bonds crumbled, and 10-year Treasury yields soared to their highest in seven months. The selloff was brutal—the worst post-meeting market reaction since the pandemic.

Investors, drunk on years of rate cuts and easy money, didn’t take the news well. Powell’s message was simple: the Fed is tapping the brakes. After three consecutive rate cuts, officials now project just two more reductions in the next 12 months.

For traders betting on a steady flow of policy easing to prop up asset prices, this was devastating. The risk-on rally that defined the past two years? It’s done.

Powell’s “neutral” stance rattles markets

Powell’s caution wasn’t entirely unexpected. Economic data has been painting a mixed picture: inflation remains above the Fed’s 2% target, while the U.S. economy has proven surprisingly resilient.

Traders had already started pricing in higher yields, pushing the 10-year Treasury rate up by 75 basis points since September. But even seasoned market participants were caught off guard by how close the Fed appears to the end of its cutting cycle.

Markets adjusted quickly—and violently. The swaps market now expects fewer than two quarter-point cuts in 2025. Some traders, like those in the Secured Overnight Financing Rate (SOFR) options market, are even betting on the Fed reversing course and hiking rates again next year.

And then there’s the wildcard: President-elect Donald Trump. With just weeks before he re-enters the White House, Trump has promised aggressive economic policies.

Higher tariffs and tax cuts are on the table, moves that economists warn could stoke inflation. Powell’s caution makes sense in this context, but it doesn’t make it any easier for traders already on edge.

Global markets feel the heat

The euro, pound, and Swiss franc each dropped over 1%, while the offshore Chinese yuan hit its lowest point since 2023. Emerging markets didn’t escape the carnage.

The Indian rupee plunged past 85 per dollar, setting a new record low. The yield on India’s 10-year bond climbed to 6.78%, and the NSE Nifty 50 index fell 0.6%.

A combination of weak regional currencies, capital outflows, and a ballooning trade deficit added pressure on the rupee.

Meanwhile, riskier corners of Wall Street, which had thrived on rate cuts and optimism about Trump’s growth policies, were hammered. Goldman Sachs’ index of most-shorted stocks dropped nearly 5%, its worst day since February.

A basket tracking profitless tech firms slid 6.4%, the sharpest fall in two years. Tesla shares tanked 8.3%, while Bitcoin, hovering near $108,000, tumbled 5%.

A hawkish pivot with lasting effects

The Fed’s decision to cut rates on Wednesday—a quarter-point reduction bringing the range to 4.25%-4.5%—should have been a relief. But the forward guidance overshadowed the cut.

Powell’s dot plot, a tool showing policymakers’ rate expectations, forecasts just two rate cuts in 2025, down from four predicted in September. Investors, already wary of stubborn inflation and solid economic growth, feared the Fed might halt cuts entirely — or even tighten again.

Stocks reacted accordingly. The Dow Jones Industrial Average dropped over 1,100 points, marking a 10-day losing streak not seen since 1974. The S&P 500 and Nasdaq fell 3% and 3.6%, respectively.

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