As expected, the Federal Open Market Committee (FOMC) lowered the federal funds rate by 25 basis points on Wednesday, this rate cut was somewhat unusual as it comes with US equity indexes trading near all-time highs.
As expected, the Federal Open Market Committee (FOMC) lowered the federal funds rate by 25 basis points on Wednesday, bringing the target rate to 4 – 4.25%. This rate cut was somewhat unusual as it comes with US equity indexes trading near all-time highs. The Fed typically eases monetary policy in response to economic weakness, so rate cuts often come during relatively weak markets. In fact, over the last 35 years, where have only been a handful of times when the Fed has cut rates when the S&P was within 1% of an all-time high.
Overall, when the Fed cuts rate when stocks are near all-time highs, equities have generally performed well over the next year. As the table below shows, since 1990, every time the fed has cut rates when the S&P was within 1% of its all-time high, the index was higher one year later, with an average gain of a little over 12%. However, we can also see that the average six-month performance is negative, with a couple of significant drawdowns. One of these was near the bottom of the COVID crash and an argument can be made that it has little to do with the pre-existing state of the market or the economy. That being said, it isn’t entirely surprising that we would see a short-term dip in these scenarios – with the market near all-time highs and signs of a slowing economy inducing the fed to cut rates.
In addition to the rate decision, the FOMC also released an updated state of economic projections (SEP) at this meeting. The SEP showed that FOMC members had lowered their projections for the level of the fed funds rate for 2025, 2026, and 2027. The new projection for the fed funds rate in 2025 – 3.6% - implies that we could see two additional 25 bps cuts this year; and the fed futures market is now pricing in a better than 90% chance of another cut next month and about an 80% chance a third cut in December.
The 10-year US Treasury Yield Index (TNX) closed higher on Wednesday and was up again on Thursday; but FOMC members’ projections that short-term rates will be about 1% lower by 2027 could help fuel additional strengthening in the core US fixed income market, which has been improving over the last several weeks.
The loosening of monetary policy has the potential to be a tailwind for both equities and core fixed income, however, there is one potential wild card. In the SEP, FOMC members also raised their projections for GDP growth in 2025 – 2027 and lowered their projections for the unemployment rate, in 2026 & 2027, which is not what you might expect when the committee is lowering rates. One explanation is that members believe that their policy adjustment will drive improvement in the economy and labor market. However, some commentators have recently discussed concerns about the Federal Reserve’s independence as a possible risk factor for the market and the seeming disconnect between the FOMC’s economic projections and policy action could lend credence to those concerns.
