No, rate cuts don’t automatically moon stocks
No, rate cuts don’t automatically moon stocks. I get why that line sticks, cheaper money sounds like instant rocket fuel. But stocks go up when the present value of future cash flows rises, which only happens if the discount rate falls and earnings don’t break. Cuts can show up right when growth is softening, and that’s when the equity math turns into a pumpkin: margins compress, earnings estimates get revised down, and multiples don’t actually expand the way the headline writers promise.
Two quick reality checks from the tape. In mid‑cycle easings, equities usually did fine. The Fed trimmed in 1995 after the 1994 hike cycle, and the S&P 500 finished 1995 up roughly 34% (price return). Same playbook in 2019: three 25 bp “insurance” cuts and the S&P 500 ended the year up about 29% (price). But when cuts coincide with recessions, different story. In 2001 the S&P 500 fell about 13%. During 2007-09, despite aggressive easing, the index dropped ~57% peak‑to‑trough and finished 2008 down ~39% for the year. Same tool, very different outcomes, because the earnings path was different.
And markets aren’t waiting around for the FOMC to say the words. They price the glide path. By the time the Fed delivered the first cut in July 2019, the 2‑year Treasury yield had already fallen roughly 100 bps from late‑2018 highs, a chunk of the “easier policy” was in the tape. That pattern repeats a lot: curves move first, risk assets react, and the statement comes after. Which is my long way of saying, don’t anchor your equity plan to the meeting calendar.
What we’ll do in this section: keep the nuance the headlines skip. Rate cuts are a condition that can help if growth holds up; they’re not a cheat code. If earnings stay resilient, lower discount rates can lift multiples. If earnings crack, the lower rate gets overwhelmed by weaker cash flows, and multiples can compress anyway. Oh, and quick clarification because it matters: a cut that stabilizes credit spreads is good; a cut that responds to stress is a different animal. Same fed funds, different signal.
- Not a guarantee: Cuts help only if earnings durability is intact.
- History rhymes: Up in mid‑cycle easings (1995, 2019). Down when cuts meet recessions (2001, 2007-09).
- Already priced: Markets move ahead of the Fed; by the announcement, part of the move is done.
Rate cuts aren’t stimulus by themselves, they’re context. Earnings do the heavy lifting.
Where are we now in 2025? Markets this year are still toggling between soft‑landing and late‑cycle, and rate expectations swing with each inflation print and growth update. We’ll map what that means for earnings resilience and for multiples, and, yeah, we’ll circle back to that pricing point so it sticks.
What actually moves prices: the math, not the vibes
What actually moves prices: the math, not the vibes. Rate cuts hit equity values through two levers: the discount rate you apply to future cash flows and the cash flows themselves. Lower policy rates pull down discount rates (which tends to lift present values ) but only if the earnings side holds up. I know that sounds obvious, but in real time the market keeps mixing the two stories, and 2025 positioning is basically a tug‑of‑war between them.
Quick math, no mystique. If you think in a simple Gordon setup, price is next year’s cash flow divided by (discount rate minus growth), shaving the discount rate from 9% to 7% with growth steady at 3% takes the “implied” multiple from about 12.5x to 16.7x. That’s roughly +33% on the multiple, before any EPS change. Flip side: if consensus EPS gets cut 20% because demand cools, you just gave back most of that lift. I’m not saying the world is this clean, but the direction is reliable.
Where rate sensitivity really bites is in long‑duration growth names, sorry, “duration” is a bond word, I mean businesses where more of the value comes from cash flows way out in the future. For those, a 100 bp drop in the discount rate can add double‑digit percent to present value because more weight sits in the back end. That’s why software and AI platform names often rally on easing signals, and why they can unwound fast if growth gets revised down even a little.
Now, if cuts arrive because the economy is slowing, the cash‑flow lever can move the wrong way. Historically, when cuts walked in with recessions, earnings fell. In 2001 S&P 500 EPS declined about 18% from peak to trough (Standard & Poor’s reported data), and in 2007-09 EPS fell over 50% peak‑to‑trough while the Fed was cutting aggressively, lower discount rates couldn’t outrun collapsing cash flows. Different cycle, same math problem.
Credit spreads sit in the middle of both stories. Equities don’t price off fed funds alone; they price off a risk‑adjusted hurdle that includes the equity risk premium, which tends to widen when high yield spreads widen. As a reminder, the ICE BofA US High Yield OAS blew out above 1,000 bps in March 2020; stocks struggled until spreads tightened. A less dramatic but useful example: in Q4 2018 HY OAS widened ~200 bps and the S&P 500 dropped ~14% that quarter. If the Fed cuts and spreads tighten, that’s supportive. If the Fed cuts and spreads widen because credit risk is rising, equities can still sag, the effective discount rate hasn’t fallen for risk assets.
Liquidity channels matter beyond the policy rate, too. Last year, the Fed slowed quantitative tightening: in May 2024 it announced a reduction in the monthly Treasury runoff cap from $60B to $25B starting June (MBS cap stayed at $35B with roll‑offs). That shift supported bank reserves and eased some plumbing stress. This year, the path of reserves (TGA swings, RRP usage, bill supply ) has occasionally mattered more for day‑to‑day risk appetite than a 25 bp tweak to fed funds, which sounds wonky but traders feel it in funding prints and in how tight financial conditions actually are.
My take, just one person’s read after too many cycles and too much coffee: in 2025 the sign on the move comes down to whether cuts lower the risk‑adjusted discount rate while EPS holds flat to up. If we get that, multiples can expand, especially for the long‑growth cohort; if cuts arrive alongside falling EPS and wider spreads, the math overwhelms the narrative. And yes, markets front‑run all this; by the time the statement hits, half the move is already in, annoying but true.
- Multiple math: 9%→7% discount rate with 3% growth implies ~+33% to the theoretical P/E; it’s fragile if EPS is cut.
- Earnings path: Cuts without EPS stability don’t help; 2001 EPS −18%, 2007-09 EPS −50%+ while rates fell.
- Spreads as referee: HY OAS at +200 bps wider quarters (e.g., Q4 2018) lined up with equity drawdowns.
- Liquidity levers: QT pace and reserves (Fed’s June 2024 QT slowdown) can nudge risk appetite, policy rate or not.
Bottom line: lower rates can lift the numerator or the denominator; stocks win when the discount rate falls and the earnings line doesn’t, simple, not easy.
Where we actually are in 2025: pricing, positioning, and the tape
Here’s the setup as we sit in late Q3 2025: the curve’s been inverted on and off since 2022, the soft‑landing vs. slowdown debate flips week to week, and the tape still pays rent to mega‑cap duration. That last bit isn’t hand‑waving, leadership concentration didn’t magically disappear after 2023’s AI ramp. As a point of reference, the top 10 names in the S&P 500 made up roughly 34-35% of index weight in 2024 (FactSet/Bloomberg tallies from last year), and while the exact figure floats around, breadth has stayed skinnier than most value managers would like.
The market’s reaction function this year has been simple, not gentle: one hot print can push out the implied path of cuts. CPI, payrolls, ISM, pick your poison. On those upside surprises, the 2‑year has tended to pop 15-25 bps the same day (you’ve seen it on your screen), and OIS curves quickly add a meeting or two before the first substantive cut. Flip it and a downside miss yanks cuts forward just as fast. It’s not new, but the elasticity is high in 2025 because the starting point is a still‑restrictive real policy rate and an economy that, while cooling at the edges, hasn’t cracked.
Volatility clusters around Fed meetings, especially the SEP updates. Positioning resets aren’t polite; they’re gap‑y. Earlier this year we had a classic sequence: hot CPI, terminals pushed up, mega‑cap growth outperformed on the “quality duration” bid, small caps lagged, and highly levered cyclicals took the brunt as rate‑path odds moved. Then, two weeks later, a softer payrolls print retraced half of it. Lather, rinse, re‑mark your book. If that sounds familiar, it’s because the playbook rhymes with every late‑cycle window since, well, 1994.
Let me circle back to breadth because it’s doing more work than it seems. Narrow leadership benefits from duration sensitivity, lower discount rates help long‑duration cash flows most, so mega‑caps can levitate on rate‑path optimism alone. Cyclicals and small caps don’t have that luxury. They need growth to validate the bull case. If ISM New Orders or payrolls wobble, they wear it, especially the names with floating‑rate debt or refi walls in 2026-2027. We saw a version of this movie in Q4 2018 when HY OAS widened by ~200 bps and equities drew down in tandem; spreads were the referee then, and they still are now.
On the curve: the 2s/10s inversion that kicked off in mid‑2022 hit depths near −100 bps at points in 2023 and only partially healed last year. Inversion isn’t a timing tool, but it keeps fixed‑income tourists jumpy and makes equity multiple expansion feel like borrowing from the future. Pair that with macro surprise sensitivity and you get a market that trades the path of rates as much as the level. I’ll admit I misremembered the exact day the 2s/10s first re‑steepened into positive territory earlier this year, it was a brief, headline‑driven session, but the big picture hasn’t changed: the curve signal is still mixed, and the tape trades.
Positioning-wise, the crowd hasn’t exactly gone off the mega‑cap growth trade. Call it habit or call it the earnings moat. The flip side is small caps and levered balance sheets keep whipsawing with every push‑pull in “will‑Fed‑rate‑cuts‑in‑2025‑inflate‑stocks” expectations. Cuts are helpful, sure, but as I said in the prior section, they help most when EPS is steady and spreads are calm. The Fed’s QT slowdown back in June 2024 nudged liquidity and risk appetite at the margin, but in 2025 the larger swings still trace back to the monthly macro prints and the SEP. Translation: be ready for fast, not elegant, resets.
Bottom line right now: the market rewards duration on benign inflation beats and punishes use when growth jitters flare. Breadth is a tell, the calendar is a catalyst, and the curve (for all its false alarms ) still frames the debate. That’s not a layup. It’s a tape you trade with your eyes on CPI day and your stops where you can sleep at night.
Who tends to win when the Fed eases (and who doesn’t)
I’ve sat through a few of these cycles now, and the pattern is familiar but never identical. Cuts change the discount rate right away; the earnings path takes its sweet time. When the two line up, you get leadership that sticks. When they don’t, you get head-fakes. I’ll lay out how I’m thinking about it now, with the caveat that this is a tape that rewards flexibility, not stubbornness. Also, for anyone searching “will-fed-rate-cuts-in-2025-inflate-stocks,” the short answer is: it depends on growth and credit, not the cut itself.
- Duration beneficiaries (software, select semis, high‑quality growth): Lower discount rates help long-duration cash flows right away. If growth holds, multiples can float higher without feeling silly. A clean example: in the last pre-recession easing stretch, 2019 saw rate cuts and style rotation into growth; the Nasdaq-100 outperformed the Russell 2000 by about 6-7 percentage points on the year (2019: QQQ +39% vs. Russell 2000 ~+25%). That was a soft-ish landing vibe with stable credit. Today, with the fed funds target still 5.25%-5.50% (unchanged since July 2023), the convexity here is high if inflation prints keep coming in benign and the 10-year drifts lower without credit stress.
- Cyclicals (industrials, transports, materials): They don’t want cuts because demand is falling; they want cuts while orders stabilize. In 2019, global PMIs bottomed and turned up into 2020 pre-COVID; industrials participated. In easing phases tied to recession (2001, 2007), cyclicals lagged until the order books visibly turned. Same playbook now: I’m watching freight rates, ISM new orders, and backlog-to-sales. No stabilization, no sustained bid.
- Financials (banks vs. insurers): Cuts can compress net interest margins if asset yields reset faster than funding costs. The shape of the curve is the swing factor. Steeper curves usually help regional banks more than just a lower policy rate. Insurers, with asset-liability matching and less deposit beta drama, tend to be steadier. A quick historical anchor: during the 2019 mini‑easing (three cuts), the KBW Bank Index rose ~32% for the year but still trailed the S&P 500’s ~31% by the Q4 melt-up and never fully escaped margin worries; life insurers outpaced some bank cohorts as long-end yields stabilized into late 2019.
- REITs and utilities: Cheaper capital helps, but balance sheet terming is everything. In a benign easing, lower cap rates and declining debt costs can lift NAVs, yet only if maturities are laddered sensibly. A useful comp: the FTSE Nareit All Equity REITs returned about 28.7% in 2019 (Nareit data), a year when the Fed cut and the 10-year fell, classic duration tailwind. Utilities saw similar beta-to-yields (XLU ~+26% in 2019). The filter in 2025: avoid short-dated debt piles and capex-heavy stories funded in the floating market. Conservative ladders win.
- Small caps: These are the purest financing-cost beta. In soft‑landing easings, they can rip; when credit tightens, they lag. Again, 2019 is a clean case: Russell 2000 ~+25% vs. S&P 500 ~+31%, good, but not leadership, because growth visibility was fine but not booming and spread compression favored quality. If we get a curve steepener and stable high-yield spreads, small can lead. If cuts arrive alongside weaker earnings revision breadth, small tends to slip.
- Highly levered or “zombie” names: Rate relief helps at the margins, but refinancing walls and spreads still bite. If the market demands 500-600 bps over Treasurys for CCC risk, a 50-75 bp policy cut doesn’t fix the model. My mental checklist: maturity schedule next 24 months, covenant headroom, and whether the business can live with today’s all-in coupons. If any of those are “ehh, not really,” I fade the pop.
One last real-world anchor I keep on my desk: in easing phases that weren’t recessionary, duration and quality usually did the heavy lifting. 2019 had three cuts, long bonds rallied, and duration assets led. In recession easings (2001, 2007-08), initial winners were also duration, but cyclicals only worked after the data turned. That’s the nuance this year. If CPI cools and growth hangs in, software, select semis, and high-quality growth can see multiple and earnings tailwinds at the same time. If growth wobbles, the market pays you to be patient and boring, not brave and levered.
My process, warts and all: watch the curve, watch spreads, and sanity-check balance sheets. Cuts are a starting pistol, not the finish line.
Frequently Asked Questions
Q: How do I position my portfolio if the Fed starts cutting later this year?
A: Treat cuts as a condition, not a cheat code. Tilt toward quality: durable cash flows, strong balance sheets, consistent margins. Keep some dry powder in T‑bills; ladder 3-12 months. Add a measured dose of duration via intermediate Treasuries or IG bond funds. Be picky on cyclicals and small caps unless earnings revisions stabilize. Watch the 2‑year yield, if it’s already slid, a lot is priced. Rebalance, don’t swing for the fences.
Q: What’s the difference between mid‑cycle cuts and recession cuts for stocks?
A: Mid‑cycle cuts usually happen when growth is fine but policymakers want insurance. Think 1995 and 2019, earnings held up and the S&P 500 finished those years roughly +34% and +29% (price). Recession cuts arrive when profits are falling: 2001 and 2008 were ugly because cash flows shrank, multiples compressed, and rates couldn’t offset the earnings hit. Same tool, different backdrop. So I focus first on forward earnings revisions and margins, then the policy path. Earnings path > policy rate.
Q: Is it better to buy stocks before the first cut or wait until after?
A: In practice, markets front‑run the Fed. By July 2019’s first cut, the 2‑year Treasury yield had already fallen ~100 bps from late‑2018 highs, easier policy was largely “in the tape.” That pattern shows up a lot, which is why trying to time “the first cut” is usually a coin flip. What’s worked better for me (and, frankly, my sanity):
- Use dollar‑cost averaging with guardrails. Increase buys when earnings revisions turn positive and credit spreads tighten; slow down if revisions are rolling over and spreads are widening.
- Let valuation be your adult supervision. Add faster when your target names trade below their 5‑ or 10‑year median EV/EBIT or FCF yield, not just becasue the Fed might cut.
- Watch the growth pulse: ISM new orders, nonfarm payrolls, and forward margin guidance on earnings calls. If those hold up, cuts can help multiples. If they crack, I keep risk lighter.
- Consider barbell sector tilts: quality tech/healthcare on one end, cash‑flowing defensives (staples, utilities) on the other; sprinkle cyclicals only when revisions stabilize.
- If you must “pre‑cut” position, scale in over weeks, not all at once. Use limit orders and be okay missing the first 3%, chasing is how you donate P&L.
Short version: process beats timing. Price the earnings path, then let policy be the tie‑breaker.
Q: Should I worry about my 60/40 if cuts arrive while growth is wobbling?
A: Worry? No. Adjust? Yeah. If growth softens, duration can help the 40 while the 60 gets choppy. I’d rebalance quarterly, upgrade bond quality, and extend duration a notch (think 5-7 year core bond funds). On equities, prioritize balance‑sheet quality and stable cash flows. Keep a 6-12 month cash bucket so you aren’t a forced seller. It’s boring, but boring survives drawdowns.
@article{will-fed-rate-cuts-in-2025-inflate-stocks-not-so-fast,
title = {Will Fed Rate Cuts in 2025 Inflate Stocks? Not So Fast},
author = {Beeri Sparks},
year = {2025},
journal = {Bankpointe},
url = {https://bankpointe.com/articles/fed-cuts-2025-stocks/}
} 