Traders on the American Stock Exchange are bracing for a pivotal moment in the financial markets, as a substantial $14 trillion rally has propelled stocks to unprecedented highs. Investors are closely watching the upcoming Federal Reserve monetary policy meeting, where there is widespread anticipation that the central bank will commence its long-awaited interest rate cuts.
The S&P 500 Index has surged 32% from its lows in April, primarily driven by expectations that the Fed will reduce interest rates multiple times this year, with a 25-basis point cut on Wednesday being almost a certainty. Historical trends offer some encouragement to bullish traders, as data from Ned Davis Research dating back to the 1970s indicates that the index has typically risen by an average of 15% a year after rate cuts resume following a pause of six months or more. In contrast, the average gain after the first cut in an ordinary cycle is around 12%.
Despite the rally, concerns linger about whether the Fed has acted swiftly enough to prevent a potential economic downturn that could hinder further gains in stock prices. While economic growth remains robust and corporate profits appear healthy, troubling signals have emerged from recent data. A recent jobs report highlighted an increase in unemployment to its highest level since 2021, causing some investors to reevaluate their strategies.
Many are adopting diverse approaches to capitalize on the anticipated shift in monetary policy, including investing in shares of smaller companies and maintaining positions in large-cap stocks that have led recent market gains. “We’re in a unique moment,” remarked Sevasti Balafas, CEO of GoalVest Advisory. “The big unknown for investors is how much the economy is slowing and how drastically the Fed will need to adjust rates. It’s tricky.”
As the Fed’s post-meeting statement is set to be announced at 2 p.m. on Wednesday, market participants will scrutinize updates in the latest quarterly rates projections, known as the dot plot, and analyze Chair Jerome Powell’s subsequent remarks. Current market dynamics show that swaps contracts fully anticipate at least a quarter-point cut, with expectations of a renewed easing cycle that was previously halted in December. Around 150 basis points of cuts are being forecasted over the coming year. If the Fed’s outlook aligns with these anticipations, stock bulls might receive a much-needed boost, reinforcing their belief in a gradual easing path that avoids a recession.
The trajectory of inflation and economic conditions for the remainder of 2025 and into the following year will be critical in shaping both the Fed’s easing cycle and the performance of the stock market, as noted by Andrew Almeida, director of investments at XY Planning Network. Historical performance suggests that the state of the economy and the pace of interest rate reductions could heavily dictate equity investors’ sector preferences.
In instances where the Fed has only implemented one or two cuts after a pause, the economy has tended to be strong, allowing cyclical sectors like financials and industrials to outperform. Conversely, in situations requiring four or more cuts, a weaker economy typically shifts investor attention toward defensive sectors, including healthcare and consumer staples.
Stuart Katz, chief investment officer at Robertson Stephens, emphasized the market’s dependence on three key factors: the speed and extent of the Fed’s rate cuts, the sustainability of the AI-led growth trend, and potential tariff-related inflation risks. The unexpected decline in producer prices in August has somewhat alleviated concerns that persistent inflation would hinder the Fed’s capacity to lower rates effectively in the coming months.
Katz has been actively purchasing shares of small-capitalization companies, which are often heavily indebted and stand to gain from lower interest rates. The small-cap Russell 2000 Index has seen a year-to-date increase of around 7.5%, while the S&P 500 has increased nearly 12%. Meanwhile, investors like Almeida are favoring mid-cap stocks, which typically outperform both large and small caps in the year following the initiation of rate cuts, and are also focusing on companies in financial and industrial sectors likely to benefit from lower borrowing costs.
Nonetheless, should signals of a more rapid economic cooling emerge, equity investors may pivot towards more defensive investments. Historical data from Ned Davis Research reveals that the S&P 500’s healthcare and consumer staples sectors have yielded average returns of roughly 20% during cycles when the Fed required deeper rate cuts. As Katz succinctly noted, “If growth slows, the Fed will cut rates, but if the economy stalls too much, recession risks will rise.” The question remains: how comfortable are investors with an impending economic slowdown? Only time will reveal the market’s response.
