Federal Reserve policymakers expect to hike their key interest rate to 5.1% next year, higher than Wall Street is counting on. The new projections, released at the end of Wednesday’s Fed meeting, were revealed along with the news everyone expected — a half-point rate hike. The S&P 500 initially turned lower on the Fed news.

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Today’s hike to a range of 4.25% to 4.5% came as the Fed stepped down its pace of tightening after four straight 75-basis-point moves.

The immediate question now is whether policymakers will take another step down at the next Fed meeting. Ahead of today’s Fed announcements, markets were pricing in 60% odds of just a quarter-point hike on Feb. 1. That fell to about 47% shortly after the Fed announcement.

Fed chair Jerome Powell will have a chance to offer guidance on the size of the next rate hike at his 2:30 p.m. ET news conference.

Fed Meeting Clarifies Rate-Hike Outlook

The new batch of quarterly projections from Fed policymakers shows the key overnight lending rate rising to 5.1% in 2023 and easing to 4.1% in 2024.

Since his August speech in Jackson Hole, Wyo., chair Powell has stressed that the Fed will have to keep interest rates higher for longer, in order to minimize risk of a protracted bout with elevated inflation, like in the 1970s.

Projections issued after the Sept. 21 meeting had indicated the federal funds rate could rise to 4.6% in 2023, before easing to 3.9% in 2024. Powell has subsequently said that the Fed’s peak rate of the cycle, or terminal rate, would likely have to rise above 4.6%.

In fact, markets had been pricing in a terminal rate of about 5.05% just ahead of Tuesday’s softer-than-expected CPI inflation data.

But in the wake of the CPI data, which showed core inflation rising just 0.2% last month, markets were pricing in a 4.9% peak rate ahead of today’s Fed meeting.

Yet there was good reason to doubt that Fed chair Jerome Powell will be swayed by the tamer readings for the consumer price index and core CPI inflation. In fact, Powell gave a speech on Nov. 30 explaining why those are wrong inflation rates for the Fed to consider.

S&P 500 Near Key Level

The S&P 500 slipped 0.4% in Wednesday afternoon stock market action, following the Fed meeting news. That reversed Tuesday’s 0.7% gain, but the S&P 500 had climbed nearly 3% at Tuesday morning highs after the tame CPI. But investors probably didn’t want to be caught wrong-footed by a hawkish Fed meeting.

The Dow Jones Industrial Average fell 0.3% after the Fed meeting, while the Nasdaq composite lost 0.7%.

The S&P 500 pushed past its 200-day line intraday on Wednesday for the second straight day, before slipping below the key technical level after the Fed meeting policy statement. The past several rally attempts back to April have stalled out at the 200-day moving average.

All the major indexes hit resistance at their Dec. 1 highs on Tuesday.

Through Tuesday’s close, the S&P 500 has rallied 10% from its Oct. 12 bear-market closing low. Still, the S&P 500 remains 18% below its record high on Jan. 3. The Dow Jones has climbed 16.5% since hitting bottom, leaving it just 9% off its all-time high. The Nasdaq has bounced 6.6% but remains 31.5% below its peak.

Be sure to read IBD’s The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.

The U.S. Economy Faces Hard Landing — Unless Federal Reserve Does This

The Fed’s New Key Inflation Rate

The specific inflation rate that Powell says the Fed and Wall Street should focus on comes from the Commerce Department’s monthly personal income and spending report, which tracks personal consumption expenditures, or PCE.

Powell’s favorite new inflation rate happens to be the most problematic one for the S&P 500. The gauge factors out goods inflation, which is rapidly falling. It also excludes housing inflation, which appears set to fall in 2023 as government data catches up to the stalling growth of market rents.

That leaves only core services other than housing, such as health care, education, hospitality and haircuts. Because price changes for such services are closely linked to wage growth, they provide the best signal of where core inflation is heading, Powell said.

The Fed’s new key inflation rate isn’t great for the S&P 500 because it puts the focus on the strongest part of the economy: the tight labor market. Until the job market cracks, wage growth is likely to remain stubbornly high, and the Fed may hike its benchmark interest rate higher and for longer than markets anticipate.

The CPI report showed that core services prices excluding shelter were flat in November vs. the prior month. But the similar PCE index won’t be quite that tame. That’s partly because the two indexes measure health care services inflation in much different ways, with the PCE measure more reflective of wage pressures. The CPI medical care services index fell 0.7% in November, the largest-ever monthly decline.

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