Fed’s Two-Cut Forecast: Fuel for Stocks or a Red Flag?
The Federal Reserve’s June 2025 decision to keep interest rates unchanged came with a strong signal: two potential rate cuts are expected before the year ends. For investors, the question now is whether this supports a continuation of the current bull market—or masks a potential correction in disguise.
What’s Priced In?
Ahead of the Fed meeting, markets widely anticipated no change in rates, and that expectation materialized. But forward-looking indicators now reflect a moderate probability of one or two cuts by the end of the year. Futures markets suggest investors are split: roughly a 56% chance of one cut by September and about a 41% chance of two cuts by December.
The takeaway is that the market has already priced in some degree of easing. The key question is whether this will be sufficient to drive equity prices higher—or whether the good news has already been baked into current valuations.
What History Tells Us: Rate Cuts and Stock Market Returns
Historically, markets have often performed well following the beginning of a Fed easing cycle. In the 12 months following a first rate cut, the S&P 500 has averaged returns north of 10%. This isn’t a guarantee, but it does highlight a trend—especially in non-recessionary environments.
However, the two major exceptions to this pattern were in 2001 and 2007. Those rate cuts came amid serious underlying economic issues: the dot-com crash and the housing market collapse, respectively. Both periods saw the S&P 500 decline over the following 12 months.
The contrast is telling: when the Fed cuts in response to mild slowdowns or to fine-tune policy, markets often respond positively. But when cuts are reactions to systemic risk, they can signal deeper trouble ahead.
Current Economic Landscape
The current macro environment presents a mixed bag. On the one hand, the labour market remains resilient. Unemployment is holding near 4.2%, and job creation continues at a moderate pace. Wages are also growing, suggesting continued demand for labour and underlying consumer strength.
Inflation, while easing, remains above the Fed’s 2% target. Core PCE sits around 2.4%, with some upward risks tied to trade policy developments. While the direction is favourable, progress may be slower than expected.
On the corporate front, S&P 500 earnings growth is expected to moderate. Forecasts have been trimmed from 12% to around 7% for the year. While still positive, this slowdown may not be enough to support current equity valuations. The forward price-to-earnings ratio for the S&P 500 hovers around 21—historically high, and potentially vulnerable to any earnings disappointments or macro shocks.
Where the Market Could Head
Bull Case: If the Fed executes two rate cuts amid stable inflation and softening—not collapsing—economic activity, it may reinforce a "soft landing" narrative. Lower rates could ease financial conditions further, support valuations, and stimulate sectors like tech and real estate. The bull market could persist, especially if corporate earnings surprise to the upside.
Bear Case: On the other hand, elevated valuations mean that good news may already be priced in. If the Fed is cutting due to deeper economic deterioration, historical precedent warns that equity markets could struggle. Furthermore, geopolitical tensions, potential inflation re-acceleration, or policy missteps could all spark volatility.
A Balanced View
Markets today are delicately poised. Investor sentiment is positive, but fragile. The bull market could extend, supported by liquidity and easing expectations. But cracks in earnings, sticky inflation, or labour market weakness could shift sentiment quickly.
A period of sideways consolidation or range-bound trading is plausible in the coming months, as investors digest incoming data and reassess risk. Volatility is likely to remain elevated, particularly around Fed announcements and inflation releases.
Conclusion The market’s response to the Fed’s two-cut outlook will depend on the underlying reasons for those cuts. If they’re preemptive and inflation continues to fall, risk assets may benefit. But if they’re reactive to economic stress, the market could pull back—just as it did in prior recession-driven cycles.
As always, Do Your Own Due Diligence and ensure risk management > prediction. Trade smart, stay adaptable, and don’t let emotions chase candles.
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