Wednesday Focus: FOMC Would be Neutral But Equity Remain Expensive
1. Market Commentary on Wednesday’s FOMC
After two consecutive days of rebound, the market resumed its decline today. The $S&P 500(.SPX)$ gained a total of 2.78% over Friday and Monday, slightly above the historical average rebound of +2.45% following a 10% correction, making it a relatively normal occurrence (see last Thursday Commentary).
The most important macro event this week is Wendesday’s FOMC meeting. Based on interest rate futures pricing, the probability of a rate cut tomorrow is only 1%. We believe this pricing is reasonable—economic weakness is not yet evident enough, and uncertainty surrounding the inflationary impact of tariff policies gives the Fed no reason to cut rates at this moment. Therefore, the market's focus will be on the dot plot and Powell’s remarks.
There are three possible scenarios for the dot plot and Powell’s speech:
Dovish: If the dot plot or Powell hints at an earlier rate cut, the stock market will likely rally.
Hawkish: If the Fed emphasizes "higher for longer" or signals a delay in rate cuts, the market is likely to continue its decline.
Neutral: If Powell avoids making explicit commitments and reiterates a data-dependent approach to maintain policy flexibility, the market may remain directionless.
Before discussing tomorrow’s FOMC, it is useful to review the Fed’s outlook for 2025 from the December meeting. The key points were:
2025 GDP Growth: Projected at 2.0%, unchanged from the September forecast.
2025 Unemployment Rate: Expected to remain at 4.3%, slightly lower than the previous estimate.
2025 Inflation Expectations: PCE inflation was revised up from 2.1% to 2.5%, suggesting the Fed expected a slower decline in inflation. Core PCE was also revised up from 2.2% to 2.5%.
2025 Target Interest Rate: The Fed raised its forecast from 3.4% to 3.9%, implying a slower pace of rate cuts.
Since the December FOMC, several new developments have emerged:
Labor Market Slightly Weaker Than Expected:
The February unemployment rate came in at 4.1%, above both the market expectation and January’s 4.0%.
Nonfarm payrolls increased by 151,000, below the 160,000 consensus, and January’s figure was revised down from 143,000 to 125,000.
Average hourly earnings rose 0.3% MoM and 4.0% YoY, both in line with expectations.
Inflation Remains Stubborn:
CPI: January headline CPI rose 3.0% YoY (above the expected 2.9%), while core CPI increased 3.3% (above the 3.1% forecast). In February, CPI rose 2.8% YoY (below the expected 2.9%), while core CPI increased 3.1% (below the 3.2% estimate).
PCE: The January PCE price index increased 2.5% YoY, in line with expectations but lower than the previous 2.6%. Core PCE rose 2.6%, also in line with forecasts.
Services PMI Remains Resilient:
January services PMI declined from 54.0 in December to 52.8, below the 54.3 forecast.
However, February's services PMI rebounded to 53.5, exceeding the expected 52.5.
Overall, no clear trend of weakening has emerged yet.
Consumer Spending Weakening:
January retail sales fell 0.9% MoM, significantly below the expected 0.2% decline.
February retail sales increased 0.2% MoM, missing the 0.6% forecast.
Additionally, January’s personal consumption expenditures (PCE) fell 0.2% MoM, below the market expectation of a 0.1% increase.
Trade Deficit Widening Sharply:
According to data released by the BEA and Census Bureau on March 6, the U.S. trade deficit widened to $131.4 billion in January, up from December’s $98.1 billion.
However, this likely reflects a temporary surge in imports ahead of anticipated tariffs, making its long-term impact on the Fed’s decision limited.
The Atlanta Fed’s GDPNow model currently projects negative real GDP growth for Q1, but this estimate is based solely on January’s trade and PCE data. A Q1 economic contraction remains unlikely.
Overall, the data available for 2025 suggests that the labor market is cooling slightly, but not significantly; inflation remains sticky without a clear downtrend; and consumer spending is weakening.
Given these factors, We expect the FOMC’s dot plot and Powell’s remarks to be neutral.
On one hand, the economy shows early signs of slowing, and the market has already pulled back—there is no need for the Fed to sound more hawkish, as it would only reduce future policy flexibility.
On the other hand, inflation has not cooled significantly, and Trump’s tariff policies introduce considerable uncertainty, making an early dovish pivot unlikely. The most probable outcome is Powell reiterating the "data-driven and wait-and-see" approach.
2. Reassessing U.S. Equity Valuations
To break down the current market correction, based on FactSet consensus:
On December 31, 2024, the $SPDR S&P 500 ETF Trust(SPY)$ 's expected 2025 EPS was $27.31; now it stands at $27.03, representing a downward revision of just 1%.
Meanwhile, SPY has declined ~7%, meaning the current selloff is largely multiple contraction rather than earnings estimate deterioration.
Looking at valuations, the NTM P/E ratio for the S&P 500 currently stands at 20.3, placing it in the 81.76th percentile of historical levels since 1999. This suggests that, despite the recent decline, U.S. equities are still not cheap. Even if valuations revert to the 75th percentile (18.21), the market still has about 10% downside—and that assumes no further EPS cuts.
Source：FactSet
Of course, looking at P/E in isolation is insufficient—we must also consider EPS growth expectations.
Below is the NTM PEG ratio for the S&P 500 since 2002: The current NTM PEG ratio of 1.9 is in the 88.6th percentile, indicating that the market isnot pricing in particularly high EPS growth, which fails to justify the elevated valuations.
Source：FactSet
If not earnings growth, could discount rates explain high valuations? The answer is no. The 10-year Treasury yield, currently at 4.28%, is in the 73.94th percentile—historically high. Normally, high discount rates should lead to lower PE/PEG ratios, but the opposite is occurring.
Another factor that could support high valuations is fiscal spending. The massive fiscal stimulus during the pandemic helped push equity valuations higher. However, the Trump administration is now prioritizing deficit reduction, which—while unlikely to reduce absolute deficits in the short term—will likely slow the pace of fiscal expansion. This policy shift further weakens the case for elevated equity valuations.
In summary, given the numerous uncertainties this year, U.S. equities remain expensive even after the recent correction.
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