On Sept. 17, the U.S. Federal Reserve cut the federal funds rate (overnight interest rate) for the first time in 2025. Policymakers were concerned about weakness in the labor market, which could be an early sign of an economic slowdown.
The Fed and Wall Street seem to agree that another interest rate cut might be appropriate at the central bank's next two-day meeting, which will be held on Oct. 28 and 29. Here's what it could mean for the S&P 500 (^GSPC 0.34%) stock market index.
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No easy decisions
The Fed has two main objectives as mandated by law. First, it aims to maintain price stability which means keeping the Consumer Price Index (CPI) measure of inflation increasing at a rate of around 2% per year. Second, it sets policy to support a healthy jobs market, but it doesn't have a specific target for the unemployment rate.
According to the most recent data from August, the CPI is increasing at an annualized rate of 2.9% this year. While it's clearly above the Fed's target, it's down significantly from 2022 when it hit a 40-year high of 8%. That inflation surge is what caused the central bank to increase the federal funds rate from 0.1% to 5.3% between 2022 and 2023.
The Fed would normally hold interest rates steady with inflation still hovering above 2%, but the jobs market has thrown a spanner in the works. The U.S. economy created just 73,000 new jobs in July, which was below the 110,000 economists expected. Plus, in that same non-farm payrolls employment report, the Bureau of Labor Statistics (BLS) revised the May and June numbers down by a combined 258,000 jobs, suggesting the economy is far weaker than initially thought.
The weakness rolled on in August, with just 22,000 jobs created during the month. The unemployment rate also hit a four-year high of 4.3%.
The September jobs report will be released this Friday, Oct. 3. Economists are expecting to see 50,000 new jobs, which would be an improvement over August, but if the official number comes in lower, it would make an October interest rate cut extremely likely.
The odds of an October rate cut are already high
The Fed released a new edition of its quarterly Summary of Economic Projections (SEP) at its September meeting. It tells the public where members of the Federal Open Market Committee (FOMC) expect interest rates, economic growth, inflation, and the unemployment rate to be over the next couple of years.
According to the SEP, policymakers already favor an interest rate cut in October, followed by another in December. Wall Street appears to agree, because the CME Group's FedWatch tool places the odds of an October interest rate cut at 89%. It also suggests there is a 71% chance of a December cut.
Further weakness in the jobs market will only bolster the consensus for lower rates.
What further rate cuts could mean for the S&P 500
Conventional wisdom suggests lower interest rates are great for stocks. They reduce borrowing costs, which is a tailwind for corporate earnings, and they allow businesses to take on more debt to fuel their growth. Falling rates also reduce the yield on risk-free assets like cash and Treasury bonds, which pushes more investors into growth assets like stocks and real estate.
However, the long-term direction of the S&P 500 is ultimately determined by corporate earnings rather than interest rates. When companies make more money, the index typically trends higher, and the reverse is also true. If the Fed is slashing interest rates because of a weak economic outlook or a full-blown recession, the S&P 500 is likely to head lower in the short term despite the various benefits of looser monetary policy.
The rising unemployment rate could be an early sign of trouble. It suggests businesses are cautious about hiring additional workers, either because they are growing more slowly than expected, or because they don't feel good about the future. A smaller workforce could also lead to a decline in overall consumer spending. None of those things bode well for earnings or, therefore, the stock market.
With all of that said, history is proof the S&P 500 has always trended higher in the long run, so any short-term weakness is likely a buying opportunity as opposed to a reason to panic sell. Corrections are a normal part of the investing journey -- it's important to be vigilant in the short term, but the U.S. economy will bounce back over time, and so will the market.
