by Jeffrey Buchbinder, Chief Equity Strategist, LPL Financial
Additional content provided by Brian Booe, Associate Analyst, Research.
The Federal Reserve (Fed) is widely expected to cut its target federal funds rate by a quarter point today. While a half-point cut is possible (markets are placing about a 5% chance on it) and adds some suspense, we think the focus for investors should be on the Fed’s outlook for the job market and inflation for the next several quarters and how their reaction function might change as the makeup of the Federal Reserve Board of Governors changes (Stephen Miran has been added, Lisa Cook is in legal limbo, and Fed Chair Jerome Powell’s term ends on May 15).
The summary of economic projections and “dot plot” that reveals where members of the Federal Open Market Committee (FOMC) expect the economy and rates to go in coming years will be interesting given the recent slowdown in job growth and relatively little upward pressure on inflation.
How Stocks Might React
The debates (25 vs. 50 basis points, two cuts in 2025 vs. three) are interesting but we’ll leave the deeper dives to our friends focused on macro and fixed income strategy. Here we focus on how stocks might react to rate cuts. Now that the one-year anniversary of the first Fed rate cut of this cycle is upon us (September 18), it’s a good time to examine how stocks have historically done during year two of Fed rate-cutting cycles. Here are the numbers.
Year Two of Fed Rate-Cutting Cycles Tends To Be Good for Stocks — If Recession Is Averted
Source: LPL Research, Bloomberg, Federal Reserve 09/16/25
Disclosures: All indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results.
Not too shabby. Most of these numbers are above zero for both the first year and second year of historical rate-cutting cycles over the past 50 years. The average gain during year one was 9.6%, and the median was 16.4%. Stocks fared better during year one of the current cycle with a more than 17% return since the half-point cut on September 18 of last year.
Turning to year two, the average and median gains were excellent at 16.4% and 14.4%, respectively. We would happily accept these returns over the next twelve months, but they may be overly optimistic given lofty valuations.
Economic Environment is Key
These are excellent historical returns, but as the accompanying chart illustrates, stocks fell during some of these cycles. Stocks fell during the 1980–81 cycles (double-dip recession), the 2001 cycle (recession), and the 2007 cutting cycle (recession). In other words, if stocks are going to rise over the next 12 months, it will likely require economic growth to continue. We think it will, supported by stable interest rates, cooling inflation, fiscal stimulus, continued robust artificial intelligence investment, productivity gains, and more rate cuts.
But this macroeconomic outlook is far from assured. Deficit spending may put upward pressure on long-term interest rates. A stalled job market may spark recession fears. Legal challenges to tariffs bring uncertainty. The geopolitical landscape is fraught with risks. And with stock valuations elevated, it’s possible that stocks produce lackluster returns even in a favorable economic environment.
Conclusion
The first year of this rate-cutting cycle has been excellent for stocks, and history offers a reason for optimism as the cycle continues. Year two of rate-cutting cycles has historically delivered solid gains for stocks — provided the economy avoids recession. Markets like rate cuts that are a luxury, not an emergency. With the Fed likely to signal more easing ahead, and near-term recession risk seemingly low, the backdrop for stocks remains constructive.
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Important Disclosures
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.
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Indexes are unmanaged and cannot be invested into directly. Index performance is not indicative of the performance of any investment and does not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
This material was prepared by LPL Financial, LLC. All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
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