Fed Rate Cut Impact on S&P 500: Historical Analysis Shows Further Upside Potential
In what’s shaping up to be a big week for the global markets, the U.S. Federal Reserve is meeting on September 16-17. The general expectation among analysts is that they’ll cut interest rates by 25 basis points.
While that’s what everyone seems to be expecting, the Fed has a history of surprising the market. If they were to cut rates by 50 basis points instead of 25, it would be an unexpected move. Looking at past events, this kind of surprise can be a powerful trigger for a significant market rally. Our analysis shows that a move like this has the potential to boost the market by 30%. A 50-point cut has the potential to really shake things up and lead to a substantial rally in the stock market.
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The Fed’s History of Exceeding Market Expectations
A closer look at recent history shows just how impactful unexpected Fed moves can be. During the COVID-19 pandemic, for example, the Fed made two emergency rate cuts in March 2020, totaling 150 basis points. The first was a 50 basis point cut on March 3rd, followed by an even more drastic 100 basis point cut on March 15th that brought rates down to near-zero.
While the market initially dropped, hitting a low of around 2,237 on March 23, 2020, the aggressive action helped stabilize investor confidence. This was a catalyst for a massive rally, with the S&P 500 reaching a high of around 4,797 by January 2022, a gain of around 115% in less than two years.
Similarly, the 2019 rate cut cycle also demonstrated the power of surprise. Starting in July 2019, the Fed made three 25 basis point cuts, with some of the later cuts being partially unexpected by the market. This series of cuts, coming after a period of rate hikes, helped to fuel a significant market run. From its low of around 2,346 in December 2018, the S&P 500 climbed to a high of 3,393 by February 2020, a 45% gain over a 14-month period. These examples highlight a clear pattern: when the Fed acts more aggressively than anticipated, it can ignite substantial and sustained market rallies.
Potential Scenarios
The current market is in a unique position. The S&P 500 is trading near all-time highs around 6,584 with a high P/E ratio of around 25, unlike previous rate-cut cycles that were often triggered by economic crises. The market has already priced in a 25 basis point cut, so a larger-than-expected move by the Fed would be a significant surprise.
Adding to the complexity is the political pressure from the Trump administration for more aggressive rate cuts. This dynamic may influence the Fed’s decision-making and, in turn, the market’s reaction.
Based on historical data, the size of a surprise cut directly impacts the potential market rally.
- Base Case (25 bp Cut): If the Fed meets expectations with a 25 basis point cut, the upside is likely to be modest. However, the market will likely see higher levels if the Fed’s commentary turns dovish—favoring economic growth and employment over inflation—instead of the hawkish stance it has held for a while. A dovish tone would signal that future rate cuts are more likely, which would be a positive signal for the market.
- Surprise Case (50 bp Cut): A 50 basis point cut or higher would be a game-changer. This unexpected move could lead to not only a short-term spike but also a medium-term rally of over 30% for the index.
To put things in perspective, the 45% rally we saw starting in 2019 was fueled by a total of 75 basis points in cuts throughout that cycle, while the 115% rally from 2020 came after a massive 150 basis points in emergency cuts. Given this, a potential 50 basis point cut—which is 25 basis points more than the expected 25 basis points cut—wouldn’t trigger a rally on that scale, but a more modest 30% gain is certainly a realistic possibility. We have historical precedents that show a “surprise” can be a powerful catalyst.
Why The Fed Might Go Big?
There are definitely some strong arguments for the Fed to go with an aggressive rate cut of 50 basis points. The biggest reason is the surprise element—since the market isn’t fully expecting it, such a move would be a powerful signal. Lowering rates also injects more liquidity into the market, which is like adding fuel to the fire. It also helps with multiple expansion, meaning investors are willing to pay more for a company’s earnings. Don’t forget the political pressure from the Trump administration, which may signal that more cuts are coming down the line.
Of course, the Fed could end up doing something else unexpected, like keeping rates steady and maintaining its hawkish stance. In this case, the market will likely be in for a rough ride. A lack of action has the potential to send the S&P 500 index down by as much as 8%. After all, inflation worries are very real. See – Will Inflation Data Crush The S&P 500? – for more details.
The Cautious View
Even with the potential for a rally, there are some mitigating factors to consider.
- High Valuations: The S&P 500’s current P/E ratio is around 25x, which is much higher than around 20x seen during the 2019 and 2020 rate cut cycle. This limits how much P/E multiples can expand. Wondering how bad things can go? Our dashboard – How Low Can Stocks Go During A Market Crash – captures how key stocks fared during and after the last seven market crashes.
- No Crisis: Unlike the emergency cuts of 2020, which were a reaction to a crisis, any cuts now would be preventive. That means there’s less “panic-driven” upside potential.
- Already at Highs: The market is already near all-time highs, so there’s not as much “catch-up” potential as there was from the crisis lows of 2020.
The upcoming Fed meeting is a high-stakes event, and any deviation from the expected 25 basis point cut will likely lead to a significant market reaction. The consistent market swings following Fed policy meetings since 2019 underscore the importance of risk management in the current environment. For instance, the Trefis High Quality portfolio has managed to outperform the S&P 500 while avoiding much of this Fed-induced carnage, delivering cumulative returns of over 91% since inception—a stark contrast to the wild ride of broad market indices.
The Bottom Line
A surprise 50-basis-point or higher Fed rate cut may still trigger a significant rally for the S&P 500, with a potential 30% gain in the medium term, based on historical data. However, the most relevant comparison is the 2019 cycle rather than the crisis-driven response of 2020. This suggests we should expect a more moderate, but still substantial, rally.
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