Record Highs as Fed Cuts Rates
The S&P 500, Dow, and Nasdaq rose by 1.22%, 1.05%, and 2.21%, respectively.
Equity markets reacted positively to the Federal Reserve’s first 25 basis point rate cut of the year, following signs of a weakening labor market and a soft housing sector.
Inflation remains above the Fed’s 2% target, especially in services, and the outlook regarding tariffs is still quite uncertain. Nonetheless, the market expects the Fed to lower rates twice more this year, in October and again in December, with more cuts to come in 2026.
The 10-year US Treasury yield ended the week at 4.13%. Gold advanced to record highs and finished the week at $3706 an ounce.
3 Things to Know
The Fed is focused on the fragility of the labor market and is intent on cushioning any potential future weakness
Reduced immigration is affecting labor supply, which Chair Powell mentioned last week today. Concurrently, on the labor demand side, political uncertainty remains elevated, tariff continuity uncertain, and companies are experimenting with Artificial Intelligence to increase productivity.
In a nod to this uncertainty around the supply of and demand for labor, Chair Powell flagged the dispersion amongst the committee’s projections regarding future interest rate cuts.
While the FOMC acknowledged “inflation has moved up,” this rate cut took place amidst the highest PCE inflation rate since the early 1990s.
This is before any tariff-induced price hikes might move firmly into inflation readings, which Chair Powell acknowledged.
Moreover, financial conditions are near the “easiest” they have been in several years, with equities just below their all-time highs, credit spreads near all-time tights, residential housing prices maintaining record levels, and interest and mortgage rates dropping from earlier this year. Indeed, the Fed’s own projection of real GDP growth is tracking at an elevated level of almost 3.4% for 3Q25.
Rate cuts with equities near all-time highs: historically positive for 1-year forward equity returns
Since 1980, the Federal Reserve reduced interest rates 13 times when the S&P 500 stood within 1% of its all-time high.
One year later, the S&P 500 delivered a positive return 100% of the time with an average return of 14.7% and a median gain of 17.5% across these 13 instances.
Importantly, this compares to an unconditional (I.E., the return in any given time frame) average S&P 500 return of 10.4% and median return of 11.9%.
Recall that the Federal Reserve reduced interest rates roughly one year ago when the index sat within 1% of its all-time high.
At the time of this writing, the S&P 500 has returned roughly 17.5% in price terms since that rate reduction on September 18, 2024, which is in line with the historical median return. In sum, over longer time horizons, new all-time highs tend to beget new all-time highs when the Federal Reserve is reducing interest rates.
Policy divergence adds fuel to the weaker U.S. Dollar trade
The narrowing spread between U.S. and German 10-year yields, which peaked in December 2024, remains a primary driver of the U.S. Dollar's depreciation year-to-date.
One can see a similar trend in U.S. versus Chinese 10-year yields, which reinforces this U.S.-driven easing of global financial conditions.
Historically, easing global financial conditions support higher carry currencies (the Brazilian Real, Mexican Peso, and South African Rand, to name a few) and their equity markets priced in U.S. dollar terms.
This U.S. Dollar trend is reinforced by ongoing monetary policy divergence. The Federal Reserve is anticipated to reduce interest rates further in the coming months, with some advocating for more aggressive easing.
On the other hand, the European Central Bank (ECB) signaled the end of disinflation last week, while the Bank of England (BOE) and Bank of Canada (BOC) are expected to hold rates steady from here.
Of note, the base case of our colleagues at Citi is for further U.S. Dollar weakness into year-end.
See our weekly CIO Strategy Bulletin for more details