What the Fed Rate Cut Means for Investors

As was widely expected, the Fed cut policy rates by 0.25% at its September meeting, continuing the easing cycle that first began in 2024. The Federal Reserve's decisions can have important effects on markets and the economy, so it helps to understand not only how much and when, but also the why of Fed’s rate cutting. And though past is no indicator of future, a little historical perspective does not hurt either.

It is important to note that the latest rate cut is fundamentally different from historical cutting cycles. Historically rate cuts have been prompted by unexpected situations. Unlike the rate cuts during the 2008 global financial crisis or the 2020 pandemic, today's move is an attempt by the Fed to fine-tune policy to sustain growth, rather than responding to a crisis. This decision comes at a time when markets are near all-time highs, but economic signals are mixed, and there is still uncertainty around tariffs and inflation.

In making its policy decisions, Fed officials study economic data including growth, jobs, and inflation to form an outlook. The Fed had been anticipating that it would cut rates for quite some time. Each of the recently published Summary of Economic Projections showed that rate cuts were likely to begin this year, even if the number and magnitude have varied.

How much and how many rate cuts can we anticipate?

To understand the magnitude and frequency of interest rate cuts, one should try to see economy from the Fed’s perspective. The Fed has a dual mandate focused on employment and inflation.

Recent economic data has been mixed on these two fronts. In recent months, the economy has added jobs below expectations. However, the unemployment rate has not gone up significantly. There are few reasons for this disconnect, some economists believe this is because many jobseekers are no longer actively looking for jobs. Another reason is the shrinking labor supply. The overall effect is a more gradual cooling of the job market. In his post-meeting press conference, Chair Powell commented that this cut was designed to keep the labor market from softening further. This approach is similar to what the Fed did last year, cutting rates in September and December by a combined 75 bps when job growth began to slow. The inflation picture is different than it was a year ago. So far, there has been less impact from tariffs on prices than was anticipated, mainly because the companies don’t appear to be passing on the full cost of tariffs to consumers. Muted inflation is allowing the Fed to focus on the labor market. At the latest press conference, Powell described this most recent policy decision as "a risk management cut" due to the Fed’s view that “downside risks to employment have risen.” This explains the modest rate cut in this round.

Answer to the question of how many cuts would the Fed be making, can be inferred from Chairman Powell’s comments. He noted the lack of consensus among the Fed members’ projections by saying that it is “not incredibly obvious what to do next.” Despite this cautious approach, the market quickly concluded the Fed will reduce interest rates at both the October and December meetings!

What rate cuts mean for investors

For investors, the critical distinction is whether rate cuts coincide with recession or support continued expansion. While there are some signs of economic weakness, there are not yet signs of a recession. In these situations, rate cuts typically provide broad benefits across financial markets. Lower borrowing costs make it cheaper for companies to finance growth and reduce debt service expenses. Consumer spending can increase if mortgage and credit card rates decline, boosting demand for goods and services.

For portfolios, history shows that the effects of rate cuts are generally positive across asset classes. While the past is no guarantee of the future, stocks typically benefit as lower rates reduce the discount rate for future earnings and improve corporate profitability, especially among growth-oriented businesses. US companies have healthy earnings and good profit margins even in this uncertain environment. However, if economic weakness intensifies, earnings will be impacted too. Also, if inflation remains stubborn, profit margins could be squeezed. And not to forget, the stock valuations are at peak, and this may limit their upside.

Bond prices tend to rise when interest rates fall. Low yields on bonds also mean less income, and cash becomes less attractive compared to investments like stocks and bonds. Lower rates may make bonds look less attractive, but keep in mind that the purpose of bonds in a portfolio is to act as a defensive play and a buffer to the stock market volatility.

Lower U.S. rates can weaken the dollar relative to currencies where rates are steadier or rising. A cheaper dollar can help exports, but it hurts imports. However, global capital flows are volatile. If rates in other regions drop or political risks rise, these dynamics can shift quickly.

Investing with these two conflicting pulls, we investors need to recognize that this cut is modest, careful, and not a sign of panic. It is also not a ticket for rapid growth. While each economic cycle is unique, navigating policy change is a normal part of investing. Importantly, balancing risk and reward requires a broad understanding of market trends. The key for the investors is to maintain perspective and staying focused on long-term financial goals rather than overreacting to each policy change.

Lavina Nagar, CFP(R) is the president and founder of Maya Advisors, Inc., a financial planning and investment firm in Palo Alto, California.