Fed rate cut sparks mixed market moves

The Fed cut rates by 25 bp, citing labor market cooling. Small caps rallied while large caps stayed flat. Mixed equity response, mild credit moves, and curve flattening signal cautious optimism. Lower rates may support equities and bonds, but risks remain.

Small-cap equities have notably underperformed in recent years, consistently lagging behind U.S. large caps amid a challenging high-rate environment. The rolling correlation chart above underscores how strong this inverse relationship between small-cap performance and interest rates has become, particularly at the long end of the yield curve. Given this pronounced negative correlation, lower yields could be supportive of a rebound in small caps.

Weekly highlights

Daily performance across assets on day of 25 bp Fed cut (September 17, 2025; source: FactSet)

The Fed’s easing cycle resumes: Market reactions and implications

The Federal Reserve has officially resumed its easing cycle with a 25 basis point (bp) cut to the federal funds rate—an action widely anticipated and largely priced in by markets. Key takeaways from the decision include a strong consensus within the Federal Open Market Committee (FOMC), with only one dissenting vote, and a clear driver behind the cut: significant cooling in labor market data.

Forecast revisions were modest. Growth projections were upgraded, while year-end inflation and unemployment forecasts remained unchanged at approximately 3.0% and 4.5%, respectively. Interestingly, the dot plot for 2026 revealed a wide dispersion among FOMC members, highlighting a lack of consensus on future growth and labor market outcomes.

Turning to markets, equities responded in a mixed fashion. Given the rate cut was largely priced in, investor attention shifted to forward guidance, which was also mixed. The expectations for two more cuts this year contrasted with the limited easing projected for 2026.

Within US large-cap equities, the S&P 500 Index ended the day mostly flat. Financials and Consumer Staples were the standout sectors, with strong performance from consumer finance, banks, financial services, credit card companies, and staples retailers. Conversely, Information Technology lagged, driven by a rotation away from growth and momentum stocks. Notably, NVIDIA weighed down the sector due to unrelated news about chip purchases in China, bringing renewed scrutiny to AI-related names.

Small-cap companies, as explored in the chart above, welcomed the cut. The Russell 2000 Index outperformed on 17 September in anticipation of a more accommodative environment.

There was considerable market rhetoric questioning the Fed’s decision to cut rates while equity markets hover near all-time highs. However, this aligns with views of market spectators who have stated “the economy is not the stock market, and the stock market is not the economy”. Despite the weakening macro backdrop, both YTD performance and earnings revisions have not shown weakness. US large-cap firms are expected to post approximately 11% earnings growth in 2025 and 13% in 2026.

In fixed income markets, treasuries were mostly weaker as the curve flattened with yields at the front end moving up a few basis points, contrary to market expectations of steepening. Despite this, we still expect short-term rates to decline as the easing cycle progresses. Corporate credit markets showed mild movements with spreads remaining at benign levels.

The US dollar initially fell alongside Treasury yields but later rebounded. This reaction is understandable, given Powell’s framing of the cut as “risk management.”

Moving forward, we believe lower rates will help support equities for several reasons:

• Valuation Boost: Lower discount rates increase the present value of future earnings.
• Cheaper Capital: Reduced borrowing costs are likely to incentivize capital investment by companies.
• Relative Attractiveness: Lower fixed income yields enhance the equity risk premium, making stocks more attractive.
• Market Sentiment: Rate cuts signal a willingness by the Fed to support the economy, providing psychological relief to investors.

Given our soft landing outlook, we believe bond markets are positioned to deliver solid returns, provided yields fall alongside the Fed’s projected rate path. That said, the latest bout of easing showed inconsistent alignment between UST yields and the Fed funds trajectory, particularly at the long end of the curve, which remains a key risk to this view.