Fed Reduces Rates as Labor Market Downside Risks Increase

United States

U.S. equity markets delivered mixed performances over the week, with most major indexes initially advancing to record highs before losing momentum toward the end of the period. Market sentiment was largely supported by the Federal Reserve’s third consecutive interest rate reduction, alongside commentary from central bank officials that investors viewed as less restrictive than anticipated.

Small-cap stocks outperformed larger peers, reflecting their greater sensitivity to interest rate movements. The Russell 2000 Index posted the strongest gain, rising 1.19% over the week. The Dow Jones Industrial Average followed with an increase of 1.05%. Mid-cap stocks, as measured by the S&P MidCap 400 Index, recorded a more modest advance. In contrast, the S&P 500 Index retreated sharply on Friday, wiping out gains accumulated earlier in the week.

Technology stocks underperformed amid renewed valuation concerns and growing skepticism regarding whether elevated spending on artificial intelligence infrastructure will generate sufficient long-term returns. These pressures weighed heavily on the Nasdaq Composite Index, which declined 1.62% over the week. Investor caution intensified after enterprise software company Oracle, a recent beneficiary of enthusiasm surrounding AI investment, reported quarterly revenues below consensus expectations on Wednesday and simultaneously signaled a significant increase in capital expenditure plans.

Federal Reserve Lowers Rates for a Third Consecutive Meeting

The Federal Reserve concluded its final policy meeting of the year on Wednesday and announced a 25-basis-point reduction in its target range for the federal funds rate, bringing it down to 3.50%–3.75%. The decision aligned with broad market expectations. However, the vote revealed notable internal disagreement, marking the first instance in six years in which three policymakers dissented. Two officials supported keeping rates unchanged, while another advocated for a larger 50-basis-point reduction.

The policy statement included language that has historically signaled a potential pause in future adjustments, stating that policymakers will carefully assess incoming economic data to determine both the timing and magnitude of any additional changes to the policy rate.

During his post-meeting press conference, Federal Reserve Chair Jerome Powell delivered a message that many investors interpreted as balanced but slightly more accommodative than feared. Powell remarked that the federal funds rate now sits within a broad range of estimates for its neutral level and emphasized that policymakers are well positioned to wait for further clarity on economic developments. At the same time, he acknowledged concerns surrounding significant downside risks to the labor market.

The Federal Reserve also announced that it would initiate purchases of shorter-term U.S. Treasury securities as necessary to ensure an ample supply of reserves on an ongoing basis.

Jobless Claims Rise While Job Openings Edge Higher

Recent labor market data added nuance to the economic picture. According to the U.S. Department of Labor, initial applications for unemployment benefits for the week ending December 6 totaled 236,000. This represented an increase of 44,000 from the previous week’s revised figure and marked the highest weekly total since early September.

In contrast, continuing claims declined by 99,000 to 1.838 million, reaching their lowest level since mid-April. This divergence suggested that while layoffs may be increasing at the margin, displaced workers are still finding reemployment relatively quickly.

Additional insight came from the Bureau of Labor Statistics, which reported that job openings in October rose to a five-month high of 7.670 million, up slightly from 7.658 million in September. Layoffs increased to 1.854 million from 1.781 million, while hires fell to 5.149 million from 5.367 million. The quits rate dropped to its lowest level since 2020, signaling reduced confidence among workers in voluntarily leaving their positions for new opportunities.

Divergence Between Short- and Long-Term Treasury Yields

U.S. Treasury markets exhibited mixed performance across maturities. Short-term yields generally declined, particularly following the Federal Reserve’s policy announcement on Wednesday. In contrast, longer-dated yields ended the week higher. Bond prices and yields move inversely, meaning that rising yields reflect weaker price performance.

Investment-grade corporate bonds outperformed Treasuries, supported by strong demand for new issuance. According to observations from T. Rowe Price traders, newly issued securities were, on average, oversubscribed, with issuance volumes broadly matching market expectations.

High yield bonds experienced some softness ahead of the Federal Reserve’s rate decision. Trading activity throughout the week was heavily influenced by credit-specific developments rather than broader macroeconomic factors.

U.S. Equity Market Performance Summary

This chart is for illustrative purposes only and does not represent the performance of any specific security. Past performance cannot guarantee future results.

Source of data: Reuters, obtained through Yahoo! Finance and Bloomberg. Closing data as of 4 p.m. ET. The Dow Jones Industrial Average, the Standard & Poor’s 500 Stock Index of blue chip stocks, the Standard & Poor’s MidCap 400 Index, and the Russell 2000 Index are unmanaged indexes representing various segments of the U.S. equity markets by market capitalization. The Nasdaq Composite is an unmanaged index representing the companies traded on the Nasdaq stock exchange and the National Market System. Frank Russell Company (Russell) is the source and owner of the Russell index data contained or reflected in these materials and all trademarks and copyrights related thereto. Russell® is a registered trademark of Russell. Russell is not responsible for the formatting or configuration of these materials or for any inaccuracy in T. Rowe Price’s presentation thereof.

Europe

In local currency terms, the pan-European STOXX Europe 600 Index finished the week marginally lower. Performance among major regional markets was mixed. Germany’s DAX Index advanced 0.66%, while Italy’s FTSE MIB gained 0.19%. France’s CAC 40 Index declined 0.57%, and the UK’s FTSE 100 Index slipped 0.19%.

European Central Bank Signals Potential Policy Tightening

European Central Bank Executive Board member Isabel Schnabel told Bloomberg that she was relatively comfortable with market expectations pointing toward higher borrowing costs rather than further reductions. She emphasized that any rate increase would depend on incoming economic data and stated that risks to both growth and inflation remain skewed to the upside.

ECB President Christine Lagarde echoed this sentiment at a Financial Times conference, noting that the European economy has demonstrated resilience amid trade tensions and is operating close to its potential. She suggested that the ECB could revise its growth projections upward at its December meeting.

Other policymakers reinforced this cautious stance. Governing Council member Gediminas Simkus indicated that additional rate cuts were unnecessary, while Francois Villeroy de Galhau stated that maintaining borrowing costs at their current level of 2.0% would be a prudent course of action.

A Reuters survey of 96 economists showed unanimous expectations that the ECB will keep its deposit rate unchanged at its upcoming meeting. Nearly 75% of respondents anticipated no change through the end of 2026, an increase from roughly two-thirds in the previous month’s poll.

United Kingdom Economic Activity Weakens

Economic data from the United Kingdom pointed to slowing momentum. Gross domestic product contracted by 0.1% in October following a similar decline in September, defying economists’ expectations for a 0.2% expansion. GDP also fell 0.1% over the three months through October.

Construction activity recorded the steepest decline, with output dropping 0.6%. The services sector, which represents the largest share of the economy, fell 0.3%. In contrast, production output rose 1.1%, supported by the resumption of activity following the Jaguar Land Rover shutdown.

The Royal Institution of Chartered Surveyors reported a notable cooling in the UK housing market during November, with demand for homes reaching a two-year low amid ongoing budget uncertainty and higher tax burdens.

Swiss National Bank Maintains Policy Rate

The Swiss National Bank left its policy rate unchanged at 0.0%, as expected. Officials cited subdued inflation and weak economic conditions as justification for maintaining the current stance.

Japan

Japanese equity markets advanced over the week. The Nikkei Index gained 0.68%, while the broader TOPIX Index rose 1.82%. The yen ended the week broadly stable, trading near JPY 155 against the U.S. dollar.

Market participants widely anticipated a Bank of Japan interest rate increase at its December 18–19 meeting. Expectations were shaped by improved communication from the central bank following the unexpected rate hike in July 2024, which had triggered market volatility.

Expectations Build Ahead of Bank of Japan Policy Decision

The yield on the 10-year Japanese government bond increased slightly to 1.95% from 1.93% at the end of the previous week. A Bloomberg survey of 50 economists indicated unanimous expectations that the BoJ would raise its key policy rate by 25 basis points to 0.75% at its final meeting of 2025. The central bank raised rates to the current 0.50% level in January.

BoJ Governor Kazuo Ueda stated that underlying inflation is converging toward the 2% target and that a tight domestic labor market continues to exert upward pressure on wages. While he acknowledged that a global slowdown in AI-related investment could pose risks to Japan’s economy, Ueda suggested that strong domestic wage-price dynamics would likely limit any sharp decline in inflation.

Japan’s final third-quarter GDP figures showed an annualized contraction of 2.3%, worse than the preliminary estimate of a 1.8% decline and below consensus expectations of a 2.0% contraction. The downward revision reflected weaker capital expenditure than initially reported.

China

Equity markets in mainland China declined as investors locked in profits following recent gains. The CSI 300 Index fell 0.08%, while the Shanghai Composite Index dropped 0.34%. In Hong Kong, the Hang Seng Index retreated 0.42%.

Inflation data for November highlighted persistent deflationary pressures. The consumer price index increased 0.7% year on year, remaining above zero for the second consecutive month. However, the producer price index declined 2.2%, marking the 38th straight month of contraction. Core CPI, excluding food and energy, remained unchanged at 1.2%.

China continues to face deflationary challenges following the pandemic, exacerbated by a prolonged housing downturn that has dampened consumer spending. Government efforts to curb excessive competition through an anti-involution campaign have so far produced limited progress.

Other Key Markets

Turkey

On Thursday, Turkiye’s central bank reduced the one-week repo auction rate by 150 basis points, lowering it from 39.5% to 38.0%. The overnight lending rate was cut from 42.5% to 41.0%, while the overnight borrowing rate declined from 38.0% to 36.5%.

Policymakers attributed the decision to lower-than-expected consumer inflation in November, driven by a downward surprise in food prices. They noted a modest improvement in the underlying inflation trend during October and November and reaffirmed their commitment to maintaining a tight monetary stance until price stability is achieved.

Brazil

Brazil’s central bank held its Selic rate steady at 15.00%, a decision that was widely anticipated and unanimous. Officials cited resilient labor market conditions, moderating economic growth, and inflation that remains above target.

Policymakers projected that inflation would ease to 3.2% by the second quarter of 2027 and emphasized that heightened uncertainty warrants a cautious and sustained contractionary monetary policy stance.