U.S. stocks slumped on Wednesday, with the S&P 500 wiping out its gains from earlier in the week, as investors reacted to the Federal Reserve's latest outlook on interest rates and the economy.

Wednesday's Fed press briefing didn't open up investors to what some felt was the worst-case scenario: That the U.S. and Israel's attacks on Iran, and the subsequent spike in global energy prices, were pushing the central bank toward another interest-rate hike.

The possibility of raising borrowing costs was discussed at the Fed's meeting this week - as it was at its previous meeting - but senior Fed officials didn't see such a move as particularly likely, Fed Chair Jerome Powell said.

Yet Powell's comments, and the latest batch of forecasts released by the central bank, made it clear to market participants that the Fed will likely remain on hold for the time being. In other words, as long as the Strait of Hormuz remains effectively closed and oil prices (CL00) (BRN00) remain high, the Fed likely won't have the flexibility to deliver the multiple rate cuts in 2026 that investors expected only a few months ago.

"The view is that Powell's press conference was a bit more hawkish than what people were expecting," Tony Rodriguez, head of fixed-income strategy at Nuveen, told MarketWatch.

In economics speak, a "hawkish" Fed generally is leaning toward raising interest rates. A "dovish" one is looking to bring interest rates down.

This realization was apparently enough to drive both stocks and bonds lower. The yield on the 2-year Treasury note BX:TMUBMUSD02Y, which is particularly sensitive to changes in investors' expectations regarding the future path of Fed interest-rate policy, rose by 7.2 basis points to 3.741%, its biggest jump in nearly a week, according to Dow Jones Market Data. Bond yields and bond prices move in opposite directions.

"The markets are reacting negatively to the likelihood that the Fed is on hold for the time being," said Eric Wallerstein, chief macro strategist at Clocktower Group, during an interview with MarketWatch.

The initial read from markets earlier in the day was one of relief, as major equity indexes moved off their session lows shortly after the Fed announced it had left interest rates unchanged.

According to Samuel Tombs, chief U.S. economist at Pantheon Macroeconomics, the main takeaway from the Fed's policy statement and latest batch of forecasts was that the central bank had not undertaken the "major hawkish pivot" that some had feared. Both the statement and forecasts were released before Powell stepped up to the lectern on Wednesday.

But that message likely got muddled as Powell started taking questions from journalists. Clocktower's Wallerstein said the central bank chairman's comments about still needing to gauge the impact of tariffs on inflation may have thrown investors for a loop.

Wallerstein said investors also were expecting more Fed officials to dissent in favor of a rate cut. But only one member of the Fed's rate-setting committee - Fed governor Stephen Miran - voted in favor of lower rates. That may have interpreted as making a rate cut even less likely this year, even though Fed officials' forecasts still have one cut penciled in.

This, combined with the latest forecast from the Fed showing that the central bank was penciling in higher inflation, likely convinced investors that the Fed would be content to sit on its hands, unless the conflict in Iran causes a substantial hit to global growth.

If that were to happen, Wallerstein said he thinks other central banks would swiftly move to cut rates and loosen their policy stance, and that the Fed would likely join them. Powell acknowledged on Wednesday that economists are typically taught to look through a temporary price shock driven by oil prices.

"If growth is weak and unemployment rises, I think global central banks would look through it and cut rates," Wallerstein said.

Over the past three months, investors have dramatically dialed back their expectations for interest-rate cuts, while the outside chance of a hike has crept back into the perceived distribution of outcomes. According to Charlie McElligott, a strategist at Nomura, the big concern in the market right now is that higher energy prices could crimp global demand and employment.

The perception that a tighter policy stance remains on the table during what feels like a precarious period for the global economy likely pushed investors to sell on Wednesday, McElligott said in written commentary.

With traditionally defensive sectors, including consumer staples, performing poorly on Wednesday, it seemed like investors were reducing their exposure to stocks across the board, he added.

By the time the dust settled, all of the major U.S. equity indexes - the S&P 500 SPX, Nasdaq Composite COMP, Dow Jones Industrial Average DJIA and Russell 2000 RUT - tallied their worst performance on a Fed day since December 2024, Dow Jones Market Data showed.

Stocks trimmed losses after the Fed announced its rates decision, then slumped once Powell starts taking questions from the press, a now familiar pattens.

The Dow fell 768.11 points, or 1.6%, to finish at 46,225.15. The Nasdaq dropped 327.11 points, or 1.5%, to 22,152.42, and the Russell 2000 shed 41.35 points, or 1.6%, at 2,478.64.