By Isabel Wang
U.S. stocks typically post strong gains after the Fed resumes interest-rate cuts. What will happen this time?
With the Federal Reserve expected to resume interest-rate cuts this week, what’s next for the stock market?
After nine months on pause, the Federal Reserve’s waiting game appears set to end this week with a long-awaited interest-rate cut. But with the stock market dancing in record territory, investors are watching whether the Fed’s decision – and its economic projections – will keep the rally alive or send the market into a tailspin.
History shows that U.S. stocks have typically posted positive returns immediately following initial rate cuts, as well as over the next 12 to 24 months. Since 1982, the S&P 500 SPX has delivered positive returns in the 12 months following such rate cuts for eight of the last 10 cycles, with an average gain of nearly 11%, according to data compiled by BMO Capital Markets (see table below).
SOURCE: BMO CAPITAL MARKETS INVESTMENT STRATEGY GROUP, FACTSET, FRB
To be sure, stock-market performance has varied significantly around these turning points – from a loss of 23.9% in 2007 to a gain of 36.2% in 1982 – largely because the macroeconomic backdrop greatly determined how effective monetary easing was in supporting growth and keeping corporate earnings on track, noted Brian Belski, chief investment strategist at BMO Capital Markets.
“In cycles where rate cuts were able to prolong economic expansion and keep corporate earnings on an upward trend, stocks performed quite well,” Belski said in a Thursday client note. “However, in cycles where monetary stimulus was unable to prevent an economic downturn like in 2001 and 2007, stocks recorded significant losses in the following year as earnings growth struggled.”
Belski and his team think the current economic conditions align with the former category courtesy of a still resilient labor market, above-trend GDP growth and solid earnings for large-cap companies on the S&P 500.
See: Stocks and bonds are sending very different messages about recession risks
But others in the market see it differently. Economic data last week showed that first-time unemployment claims climbed to the highest level since 2021, adding to a downward revision in U.S. payroll growth as evidence that the labor market may be losing steam at a quicker pace than previously thought.
While that appears to firmly support the case for a Fed easing this week, the inflation backdrop tells a different story. Last week, both August wholesale- and consumer-price reports showed that inflation remained elevated well above the Fed’s 2% target. That has put policymakers in a tough spot as they seem ready to lower policy rates by 25 basis points, to a range of 4% to 4.25%, on Wednesday.
That’s why investors are laser-focused not just on the policy decision itself, but also on Fed Chair Jerome Powell’s press conference and the updated Summary of Economic Projections – also known as the “dot plot” – which will show where policymakers expect the federal-funds rate to be by the end of this year and in 2026.
“Investors are looking for Powell [and fellow policymakers] to explain themselves, as he will likely say the Fed is watching the data – but if they are data-dependent and inflation is still a distance away from their target, why are they willing to look past this inflation?” said David Bianco, chief investment officer of Americas at DWS.
Bianco noted that the risk of slightly higher inflation has been balanced by the risk of a moderately weaker labor market, and that trade-off is likely how the Fed will justify a rate cut this time.
“But I think there’s much greater harm to the U.S. economy over the long term should it be the case that inflation accelerates or stays high, versus a mild recession,” he told MarketWatch in a phone interview on Thursday.
Just three months ago, policymakers projected the unemployment rate would climb to 4.5% by the end of the year and into 2026, before edging down to 4.4% in 2027. By August, the actual unemployment rate stood at 4.3%, according to the Bureau of Labor Statistics.
“It’s the changes in unemployment rate within the Summary of Economic Protections that would be the biggest signal to the financial market on Wednesday,” said Tony Rodriguez, head of fixed-income strategy at Nuveen.
“If investors see a tick up in those unemployment levels for year-end 2026 and 2027, that would be supportive of saying [that] maybe they need to increase their expected Fed cuts for next year – because the Fed is moving much more in that direction of expecting further economic weakness that would require some monetary support,” Rodriguez told MarketWatch via phone.
Still, it’s possible that the dot plot shows the market is far ahead of the Fed’s view on cuts, which could trigger elevated volatility in the stock market this week, said Alicia Levine, head of investment strategy and equities at BNY Wealth.
Fed-fund futures traders on Friday were pricing in two to three interest-rate cuts by the end of 2025, with at least three to four more reductions expected in 2026, according to the CME FedWatch Tool.
“The concern is the market might be getting ahead of itself, but also that we do have a degradation in the labor market, and we don’t know if that signals anything more noxious down the road,” Levine told MarketWatch in a phone interview. “I don’t think the Fed is going to prioritize inflation over a labor market that looks quite weak.”
U.S. stocks finished mostly lower on Friday but still managed to post strong weekly gains, fueled by a surge in megacap technology names like Oracle Corp. (ORCL) and Google parent Alphabet Inc. (GOOG) (GOOGL)
The S&P 500 advanced 1.6% for the week, while the Dow Jones Industrial Average DJIA gained nearly 1% and the Nasdaq Composite COMP rose more than 2%, according to FactSet data.
With markets sitting around record levels, investors are debating whether lofty valuations could make them especially vulnerable to Fed-related volatility this week.
But Levine said she thinks stocks being at all-time highs doesn’t necessarily mean markets are “frothy,” as earnings estimates are also moving higher.
The S&P 500 was trading at a forward price-to-earnings ratio of 21.8 on Friday afternoon. The benchmark index is also projected to see a year-over-year earnings growth rate of 7.6% in the third quarter of 2025. If that estimate holds, it would be the ninth straight quarter of earnings growth for the S&P 500, according to FactSet data.
“When the Fed cuts into an earnings-estimate upswing, that tends to be very positive for markets,” Levine added.
-Isabel Wang
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09-14-25 1200ET
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