The artificial intelligence (AI) boom continued to create trillions of dollars in value for tech and tech-adjacent companies in 2025, which propelled the S&P 500 (^GSPC 1.11%) stock market index to new record highs. But investors benefited from another important tailwind last year: interest rate cuts.
Falling interest rates reduce the cost of debt, which typically boosts corporate profits. They also allow companies to borrow more money to fuel their growth, which can accelerate returns for investors. The U.S. Federal Reserve is currently trying to contain a rising unemployment rate, which is signaling cracks in the economy, so Wall Street is predicting more interest rate cuts during 2026.
Although even lower rates would be great for the stock market in theory, they can have the opposite effect if investors fear a recession is on the way. Here's when the next rate cut is expected, and what it could mean for your stock portfolio.
Image source: Getty Images.
The Fed is battling a rising unemployment rate
The Fed has two main objectives. First, it aims to maintain price stability, which means keeping the Consumer Price Index (CPI) measure of inflation increasing by around 2% annually. Second, it aims to keep the economy running at full employment, but it doesn't have a specific target for the unemployment rate.
The CPI spent the whole of 2025 above the Fed's 2% target, and the latest reading from November showed an annualized inflation rate of 2.7%. Policymakers would normally hesitate to lower interest rates under these circumstances, but the jobs market forced their hand as 2025 drew to a close.
The concern started in July, when the U.S. economy added just 73,000 jobs for the month, which was way below economists' estimate of 110,000. But in that same nonfarm payrolls report, the Bureau of Labor Statistics also revised its May and June numbers down by a combined 258,000 jobs, suggesting the economy was on much shakier ground than originally thought.
A series of weak monthly jobs reports followed, pushing the unemployment rate up to 4.6% in November, which was the highest level in more than four years.
US Unemployment Rate data by YCharts
To make matters worse, in a speech on Dec. 10, Fed chairman Jerome Powell said that recent employment numbers might actually be overstated by around 60,000 jobs per month due to issues with the data collection process. By his estimation, the economy might be losing 20,000 jobs per month right now.
Therefore, it's no surprise the Fed cut interest rates in December. It was the third cut of 2025, and the sixth since September 2024.
Two more rate cuts could be on the way in 2026
In the December edition of the Fed's quarterly Summary of Economic Projections (SEP) report, policymakers on the Federal Open Market Committee (FOMC) increased their consensus economic growth forecast for 2026. This isn't a surprise, because the last few interest rate cuts are likely to spark at least some increase in economic activity this year.
Nevertheless, most FOMC members still expect at least one more cut in 2026 because of the recent cracks in the jobs market, and Wall Street appears to agree. The CME Group's FedWatch tool, which calculates the probability of interest rate moves based on trading activity in the Fed funds futures market, points to two cuts in 2026 -- one in April, and one in September.
What do further rate cuts mean for the stock market?
As I mentioned at the top, falling interest rates are typically great for the stock market because they boost corporate earnings. However, the rising unemployment rate could be an early recession indicator. If one does eventuate, earnings could take a hit from here as consumers and businesses trim their spending.
The stock market would probably trend lower in that scenario, even if the Fed was aggressively cutting interest rates. There have been a few examples of this over the last 25 years, when economic shocks like the dot-com crash, the global financial crisis, and the COVID-19 pandemic sent the S&P 500 plunging, despite supportive monetary policy from the Fed.
There is no sign of a dire economic event on the horizon right now, but investors should look out for further weakness in the jobs market and treat it as a potential warning sign.
To finish on a more positive note, the S&P 500 ended 2025 near a record high, which is proof that every sell-off, correction, and bear market throughout its history was a mere short-term blip. Therefore, if an economic downturn does trigger weakness in the stock market in 2026, long-term investors might want to treat it as a buying opportunity.
