Will the Fed’s Rate Cut Trigger a Stock Market Drop Instead of a Rally?

TradingKey - After a 9-month pause, the Federal Reserve is all but certain to restart its easing cycle at this week’s FOMC meeting. While lower borrowing costs should theoretically boost liquidity and support U.S. equities, deeper concerns about an impending economic slowdown, and the risk that rate cuts have already been priced in too aggressively, suggest the market may be approaching not a continuation of the bull run — but a turning point.

The Fed will announce its monetary policy decision on Wednesday, September 17. Wall Street economists widely expect a 25-basis-point cut, lowering the federal funds rate to a range of 4.00%–4.25%.

This would mark the first rate cut since December 2024. Given the recent string of unexpectedly weak employment reports, some analysts are even considering a 50-bp cut as a plausible scenario.

Economic Context Determines the Net Impact

In theory, looser monetary policy supports corporate activity and encourages capital flows into risk assets like stocks. According to BMO Capital Markets, in eight out of ten rate-cutting cycles since 1982, the S&P 500 rose over the following 12 months, with an average gain of 11%.

However, stock market performance after rate cuts has varied dramatically:

• 2007: S&P 500 fell 23.9% in the year after the first cut
• 1982: Rose 36.2%

BMO analysts noted that the macroeconomic backdrop determines whether rate cuts successfully stimulate growth and stabilize earnings.

When rate cuts extend an economic expansion and help maintain corporate profits, markets tend to rally. But in cycles like 2001 and 2007, where monetary easing failed to prevent recession, earnings deteriorated, and equity markets weakened sharply in the following year.

BMO believes today’s environment resembles the positive scenarios, citing:

• Resilient labor market
• GDP growth above long-term trend
• Strong earnings from large-cap S&P 500 companies

Yet JPMorgan strategist David Kelly argues there’s evidence the economy is gradually slowing, and rate cuts are unlikely to reverse that trend.

Kelly said that if the market thinks rate cuts signal any benefit for overall economic direction or profitability, that’s a pure misreading.

He added that when the Fed cuts rates, it signals fear of recession — and that’s what makes investors start fearing one too.

Even if the U.S. avoids a formal recession, slower growth could disappoint investors who’ve priced in strong profit gains.

Markets Are Ahead of Themselves — And Risk Being “Priced In”

Many analysts warn investors to closely watch the Fed’s updated Summary of Economic Projections (SEP), which reflects policymakers’ outlook on inflation, growth, and unemployment.

David Bianco, Chief Investment Officer at DWS, said the Fed’s rationale for cutting — moderate labor market softness outweighing slight inflation rebound — is sound. However, he cautioned that persistent or rising inflation poses a greater long-term threat to the U.S. economy.

Some analysts believe changes in unemployment forecasts could send the strongest signal to financial markets. If the Fed raises its jobless rate projections for the next two years, it reinforces the case for more cuts. But if labor market deterioration proves milder than feared, stocks could face a pullback.

BNY Wealth warned:

“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.”

JPMorgan said last week that the upcoming rate cut might not lift stocks, but instead become a catalyst for profit-taking and temporary exits — highlighting the “sell the news” risk.

So far in 2025, the S&P 500 has set new highs over 20 times, with rate cut expectations serving as a key driver.

Beyond tariff-driven cost pressures, JPMorgan also pointed to weakening internal supports for the rally:

• Rate cuts themselves could reignite inflationary pressures
• Seasonal weakness in September
• Low retail investor participation
• Reduced corporate buybacks ahead of Q3 earnings season