The Federal Reserve's "hawkish rate cut" arrived as expected. Why did the market rise instead of fall?

Federal Reserve cuts interest rates by 25 basis points to 3.5-3.75%, but the decision passes 9 to 3, the largest opposition record since 2019. The market’s reaction was unexpected, with the Dow surging 497 points, up 1.1%, and Bitcoin briefly soaring to $94,000. Fed Chair Powell stated that “rate hikes are not anyone’s baseline expectation,” and announced the purchase of $40 billion in Treasury bonds within 30 days starting December 12, igniting bullish market sentiment.

Powell’s Two Words Reversing Market Expectations

Powell’s two key statements at the press conference became the direct catalyst for the market’s sharp rally. The first was “rate hikes are not anyone’s baseline expectation,” which completely dispelled fears that the Fed might turn hawkish again due to inflation rebound. The second was “we have an unusually strong economy,” coupled with the Fed raising its 2026 GDP growth forecast from 1.8% to 2.3%, providing fundamental support for risk assets.

Powell emphasized that the current benchmark interest rate is in a “broadly neutral zone,” neither clearly restraining the economy nor significantly boosting demand, placing the Fed “in a good position to wait and observe how the economy evolves.” He pointed out that the cumulative 175 basis points cut since last year has already provided considerable support, making it more appropriate to be patient and wait for data at this stage.

Regarding the controversy over this rate cut, Powell unusually acknowledged it was a “very close call.” He said, “I can find sufficient reasons both for and against a rate cut. The current economic situation is highly complex, and of course, we hope the data can provide clearer guidance.” This candid statement instead reassured the market, showing that the Fed is not rigidly executing a preset path but is genuinely adjusting flexibly based on data.

On inflation concerns, Powell stated that recent rise in commodity prices mainly reflects a one-time shock caused by tariffs, and does not mean the inflation trend is reigniting. He emphasized the need to ensure that “one-time price increases do not evolve into a persistent inflation problem.” This clear stance on the nature of inflation reassures the market that the Fed will not overreact to short-term price fluctuations.

The Hidden Easing Effect of the $40 Billion Bond Purchase Plan

The Fed announced it will start purchasing short-term Treasury bills (T-bills) from December 12, with an initial monthly scale of $40 billion. This move nominally aims to ease pressures in the overnight funding markets and keep the federal funds rate within the target range, but the market generally views it as a positive for risk assets, with a “hidden easing” effect.

Although officials emphasized this is a technical operation rather than quantitative easing (QE), the effect is similar. By purchasing government bonds, the Fed injects cash directly into the banking system, increasing base money supply. When liquidity is abundant, funds tend to seek higher yields, making risk assets like stocks, gold, and cryptocurrencies the preferred options. While $40 billion is smaller than the scale of QE, in the current market environment, this clear liquidity signal can trigger reallocations of funds.

Kobeissi analysts pointed out that this represents a direct liquidity injection into the financial system, which could lead to substantial rises in risk assets like Bitcoin. Historical experience shows that Fed balance sheet expansions usually correlate positively with risk asset prices. The massive QE during the COVID-19 pandemic pushed Bitcoin from $5,000 to $60,000, which is the most obvious example. Although the current $40 billion scale is much smaller, the directional significance is substantial.

Triple Logic Supporting the Market Surge

No more rate hike risk: Powell’s clear stance eliminates fears of tightening, easing risk assets

Direct liquidity injection: $40 billion bond purchases provide immediate liquidity support

Upgraded economic outlook: GDP forecast raised to 2.3%, boosting corporate earnings expectations

The market’s immediate reaction to this meeting fully reflects these three logical pillars. The Dow Jones Industrial Average rose 1.2%, over 600 points, the S&P 500 increased 0.8% to new highs, and the Russell 2000 small-cap index also hit a record high. Investors generally interpret Powell’s statement ruling out a rate hike as a policy dovish signal, while also betting that the Fed may be forced to implement deeper rate cuts next year.

Internal Divisions and Contradictory Dot Plot Signals

The most shocking aspect of this Fed rate cut decision is the severity of internal divisions. The decision passed 9 to 3, the highest opposition since 2019. Even more notably, the three dissenters come from opposite ends of the policy spectrum: dovish Governor Stephen Miran advocated for a one-time 50 basis points cut, while hawks Chicago Fed President Austan Goolsbee and Kansas City Fed President Jeffrey Schmid believed rates should be kept unchanged.

Additionally, among the 19 participants, 6 indicated they would not support this rate cut, forming a “soft opposition.” This reveals an unprecedented split within the committee over policy direction. The root cause of this division is conflicting economic signals: the labor market is softening, but inflation has risen due to tariffs. Powell said, “Many members believe that the risk of rising unemployment is increasing, and so is the risk of rising inflation. This is a very challenging situation.”

The latest dot plot shows that the Fed’s projections for future interest rates remain largely unchanged: only one rate cut is expected in 2026, another in 2027, with the long-term median rate still near 3%. However, futures markets imply a 38% chance of two rate cuts next year, indicating market expectations that the Fed might act more aggressively than the official forecast.

Bloomberg US Chief Economist Anna Wong commented: “The overall tone is dovish but with cautious signals.” She believes the Fed could ultimately cut a total of 100 basis points next year because “wage growth is clearly slowing, and there is no sign that inflation will accelerate again in the first half of 2026.” This divergence between market expectations and Fed projections leaves future policy paths uncertain.

Why Does a Hawkish Rate Cut Spark Market Cheers?

Despite the Fed signaling a cautious stance and emphasizing higher thresholds for future rate cuts, market sentiment is clearly optimistic. US stocks closed higher: Dow up 497.46 points or 1.1%, S&P 500 rose 0.7% to a new high, Nasdaq gained 0.3%. Spot gold closed up $20.20 or 0.48%, briefly touching $4,238.78, up $57 from the intraday low. Spot silver also hit a new high, approaching $62.

This contrast indicates that investors believe: although the Fed’s tone is hawkish, monetary policy remains accommodative. Informa Global Markets stated that the FOMC decision was mildly dovish because only two members opposed the rate cut. Wall Street is prepared for more hawkish comments from inflation hawks, but when it came to the vote, the hawks yielded.