In response to the Federal Reserve’s decision to implement a 25-basis-point interest rate cut, market reactions have exhibited typical volatility. The Fed’s accompanying outlook indicated the possibility of two additional rate cuts later this year, but the anticipated complete reassurances regarding inflation concerns were not fully conveyed. This led to an initial market shift, reflecting a strategy commonly seen during Fed easing: a rotation away from high-value growth stocks into lower-quality, more cyclical small-cap companies and financial stocks.
However, this trade’s momentum quickly faltered. During the post-announcement press conference, Fed Chair Jerome Powell emphasized the “two-way risk” concerning both inflation and full employment, causing some initial market unease. Following the Fed’s announcement, Treasury yields rose as investors processed the broader outlook presented in the “dot plot,” which projected several more rate cuts into the following year, even as the inflation estimate from the Personal Consumption Expenditures (PCE) index was revised upward slightly.
As the Fed board is expected to take a more dovish stance in the future, particularly following potential appointments by President Trump, the notion of a “run it hot” economic strategy has begun to gain traction. While current Treasury yields remain manageable, there was noticeable selling pressure from holders after a recent strong rally, signifying growing concerns about the economic horizon.
In a broader context, the stock market has been on a steady upward trajectory, but signs of fatigue are evident beneath the surface. Efforts are underway to address imbalances in the market, particularly by reducing exposure to the high-performing “Magnificent 7” stocks. As the market adjusts, the median stocks—represented by the equal-weighted S&P 500—have shown stronger performance, reflecting a focus on artificial intelligence (AI) and sustainable earnings growth. History suggests a pattern of positive market performance following past rate cuts, especially when stocks were already near record highs.
Currently, the S&P 500 and Nasdaq-100 are trading at elevated forward price-to-earnings ratios of 23 and 28, respectively. These valuations are buoyed by tight credit spreads, anticipated soft-landing scenarios from rate cuts, substantial capital expenditures in AI, and strengthened consumer spending among upper-income brackets due to a robust wealth effect. Despite this optimistic backdrop, market participants are reminded that late September can often introduce volatility, and past instances of rate cuts in bull markets have yielded varying short-term responses.
