Rate Cuts in Rare Air: History’s Edge

• The Fed struck a more dovish tone than investors anticipated.

• It also lowered rates with the market near new highs.

• The S&P 500 Index tends to rally 36% over the following 2 years.

When the central bank eases while stocks hover near records, investors should pay close attention…

The Federal Reserve’s monetary policy meeting was far from what investors had anticipated. Going in, it was widely expected that our central bank would lower interest rates by 25 basis points. But afterward, Wall Street believed the policy path would take a more hawkish turn.

The rate cut was delivered as expected. And the initial guidance was for one rate cut in 2026. Based on those two items, one could argue the outcome was a hawkish cut. But there are two more important signals that point to a more dovish direction.

The first was an announcement that the central bank would start purchasing $40 billion in short‑term Treasuries this month, with plans to taper the program sometime in the middle of next year. That will expand the balance sheet and inject cash back into the financial system. That’s akin to another rate cut.

The second was guidance for stronger domestic growth and lower inflation in 2026. That leaves the door open for more rate cuts than expected. You can see what I mean by looking at the most recent Summary of Economic Projections…

Source: Federal Reserve

But while all of this was taking place, there was another important signal that happened.  For the third time this year, our central bank cut interest rates while the S&P 500 was within 1% of its all-time highs. Historically, that’s been a strong setup for stocks.

But don’t take my word for it, let’s look at what the data’s telling us…

If you’ve followed my work, you know I pay close attention to Fed policy. Why? Because it shapes the liquidity backdrop for both institutional and retail investors. When borrowing costs fall and money gets easier to access, investors have more fuel to buy assets. When rates rise, that asset propellant dries up.

In my view, rates still have room to fall. Based on my estimate of the real fed funds rate (effective fed funds rate minus inflation), the Fed could cut another 125 basis points before hitting neutral, where policy neither stimulates nor restrains the economy. In addition, the current makeup of the FOMC, through 2027, leans dovish. That means more cuts are likely.

Given that backdrop, I wanted to see what it could mean for stocks. After all, it’s one thing to say stocks rally when the Fed cuts rates but it’s another to prove it.

To find out, I looked at every instance since 1980 when the Fed cut rates while the S&P 500 was within 1% of a record high. I used the closing price on the day of the rate cut as the starting point and calculated total returns (with dividends reinvested).

Here’s what I found for the S&P 500…

Source: Bloomberg

As you can see in the table above, this scenario has played out quite a few times. Based on the results, the S&P 500 has averaged a 17.6% increase 12 months later and a 35.9% gain after 24 months. That compares to the annual average of 9.5% since 1928. In addition, those time frames have had a perfect track record.  

Now, when the Fed lowered rates in September and October, the Nasdaq Composite was within 1% of its high. This time, it was not. Still, it’s worth highlighting the typical outcome given what happened earlier this year…

Source: Bloomberg

Based on the results, the Nasdaq has averaged a 17.2% increase 12 months later and a 27.1% gain after 24 months. That compares to the annual average of 11% since 1971. And a success rate of 83% and 91% for the one- and two-year time frames isn’t too shabby.

So, like I said at the start, it’s important to follow our centrals bank’s decisions from a liquidity perspective. Because, the Fed’s actions aren’t just policy, they’re signals. And when those signals align with market strength, history has a way of rewarding those who remain patient and stay the course.

That’s not just optimism. That’s history talking.

Five Stories Moving the Market:

Oracle sales and profit that missed analyst estimates, while saying that spending would rise by $15 billion compared with earlier estimates - a sign that big capital outlays to chase AI cloud-computing customers is not turning into profit as fast as Wall Street had expected – Reuters. (Why you should care – the company reported Remaining Performance Obligations of $523 billion compared to $455 billion in the prior quarter)

Adobe delivered an upbeat annual forecast but still drew a lukewarm reaction from investors, who have been seeking clearer signs that the software maker can thrive in an era of artificial intelligence; revenue guidance for $25.9 billion to $26.1 billion in the fiscal year ending in November 2026 was below some of the more aggressive expectations – Bloomberg. (Why you should care – investors remain worried that generative AI could hurt Adobe’s business)

The Federal Reserve cut interest rates but signaled borrowing costs are unlikely to drop further in the near term as it awaits clarity on the direction of a job market showing signs of softening, inflation that "remains somewhat elevated" and an economy it sees picking up steam next year – Reuters. (Why you should care – Fed  policy projections left the 2026 outlook unchanged at just one rate cut)

The Federal Reserve is ready to expand its balance sheet once more by buying short-term Treasury securities, aiming to head off bouts of pressure in overnight lending markets that are critical to the broader financial system; the Fed said it would start its balance-sheet expansion with $40 billion of securities purchases this month, with plans to taper the pace of the new buying sometime next year – WSJ. (Why you should care – increasing Treasury purchases is akin to lowering interest rates)

Batteries are getting cheaper and allowing solar power to be used beyond daylight hours, according to new analysis from clean energy think tank Ember; the costs of building giant, utility-scale batteries globally have declined significantly in recent years — including a 40% drop in 2024 — and have room to fall further – Bloomberg. (Why you should care – affordability and ease of construction is increasing the appeal of solar as an energy source) 

Economic Calendar:

Earnings: AVGO, COST, LULU

Swiss National Bank Monetary Policy Announcement (3:30 a.m.)

SNB’s Schlegel (Chair) Speaks (4:30 a.m.)

BOE’s Bailey (Governor) Speaks (4:50 a.m.)

Eurozone – Eurogroup Meetings (5:00 a.m.)

U.S. – OPEC Monthly Report (7:00 a.m.)

U.S. - Initial Jobless Claims (8:30 a.m.)

U.S. - Continuing Claims (8:30 a.m.)

U.S. – Exports, Imports September (8:30 a.m.)

Canada – Exports, Imports for September (8:30 a.m.)

U.S. – Wholesale Inventories for September (10:00 a.m.)

Treasury Auctions $22 Billion in 30-Year Bonds (1 p.m.)

Fed's Balance Sheet Update (4:30 p.m.)