Could rate cuts, economic resiliency spark an end-of-year rally?

The much-anticipated rate cut from the Fed arrived, and with it, an indication that two more rate reductions may follow before year-end.¹ Naturally, investors are asking how markets tend to behave during easing cycles. The answer depends largely on the state of the economy. For example, market performance in the year following the rate cuts in 1973 and 2007 — when the economy was on the brink of severe recession — was markedly lower than the more favourable outcomes following the rate cuts in 1984 and 1995.² Fortunately, today’s economic backdrop shows few signs of an impending recession, which continues to support a constructive outlook for stocks.

The primary risk to this view may lie in the future of Fed independence. Encouragingly, the September Federal Open Market Committee (FOMC) meeting showed a broad consensus around a measured 25-basis point cut, with only one dissenter. This suggests that despite pressure from the administration for more aggressive easing, the current committee (including Trump appointees such as Christoper Waller and Michelle Bowman) is proceeding cautiously. Inflation expectations remain anchored,³ and while the dollar has weakened, it’s not under significant stress.⁴ All told, we believe the current environment appears conducive to an end-of-year rally, with cyclical and smaller capitalisation stocks and non-US assets expected to potentially benefit.

Fed takes a more proactive approach

September’s cut was the first for the Fed since December 2024 and reduced the benchmark interest rate a quarter percentage point to a target range between 4.00%–4.25%.5 In his post-meeting remarks, Fed Chairman Jerome Powell noted that “downside risks to employment have risen” and characterised the move as a “risk management cut,”6 likely intended to preempt further softening in the labour market. This shift toward a more proactive policy stance was reinforced by the Fed’s Summary of Economic Projections (SEP), which showed officials anticipate two additional 25-basis point cuts by year-end, followed by another two cuts through 2027.⁷

Interestingly, the Fed’s updated projections also showed upward revisions to both their economic growth and inflation forecasts, alongside downward revisions to their unemployment rate projection.⁸ This suggests the Fed may be easing policy in the coming years, but not in response to deteriorating conditions. Rather, against a backdrop of accelerating growth fueled by accommodative fiscal and monetary policy and decelerating (though still elevated) inflation amid resurging demand and potential supply constraints.

Cuts into a cyclical recovery?

Recent economic data suggests the US economy may be turning a corner just as the Fed begins its easing cycle.

• August retail sales rose 0.6% month-over-month and 5.0% year-over-year⁹ — a potential sign of rebounding consumer demand following a moderate slowdown in the first half of the year. This report marked the third consecutive monthly increase in retail sales, which potentially reflects underlying economic resilience and should bode well for US gross domestic product (GDP) growth in the third quarter.
• Initial jobless claims experienced their largest drop in four years, falling by 33,000 to 231,000 for the week ending 13 September.¹⁰ This figure is consistent with the post-pandemic trend and suggests that layoffs remain largely contained, despite a slowdown in job openings and hiring.

With the Fed now cutting rates and projecting further easing through the end of this year and into 2027, the mix of resilient consumption and stabilising labour market data could signal the beginning of a cyclical rebound in the US economy.

Three key implications for markets

The combination of proactive easing and resilient economic fundamentals could have three important implications for markets, in our view:

• Cyclical, value-oriented, and smaller-capitalisation stocks have the potential to outperform as growth expectations rise and financial conditions loosen.
• The US Treasury yield curve may steepen as short-term rates fall in response to Fed cuts, while long-term yields rise, reflecting expectations for higher growth and inflation.
• The US dollar may weaken further as the Fed cuts rates with inflation still above target, potentially benefitting commodities and non-US assets, particularly in emerging markets.

Overall, rate cuts not followed by a recession have tended to be supportive of stocks. Investors concerned about an unexpected slowdown in growth, however, have historically been rewarded by using high-quality intermediate-duration fixed income as a way to hedge that risk.¹¹

Bank of England: No surprise

The Bank of England’s Monetary Policy Committee (MPC) voted 7–2 to hold its bank rate at 4% last week. The outcome and vote split were widely expected. Governor Andrew Bailey’s comments after the meeting pointed toward a pause in the cutting cycle through the end of the year.

The MPC reduced the pace of quantitative tightening. The annual Asset Purchase Facility was reduced by 30 billion euros to 70 billion euros, while active sales increased to 21 billion euros. Increasing active sales allows the focus to be biased toward the short and medium end of the rates curve, thus reducing pressure at the long end, where rates have been rising recently with fiscal worries.

Bank of Japan: Hawkish hold and asset sales announced

The BOJ held its policy rate at 0.5% last week. Two members of the board voted for a hike. Some have read that as a hawkish tilt, though we wouldn’t interpret it as changing the general profile of the BOJ. The BOJ is the outlier of the major central banks in that it remains in the hiking, rather than cutting, phase of the cycle.

The BOJ announced it will sell 330 billion yen of exchange-traded funds (ETFs) and 5 billion yen of Japan Real Estate Investment Trusts per year that it currently holds on its balance sheet. This should have little impact on these markets as these values amount to approximately 0.05% of daily average turnover according to the BOJ. The pace will be adapted if market conditions dictate.