The Federal Reserve lowered its key interest rate last month by half a percent, signaling the end of higher interest rates for longer and the beginning of a rate cutting cycle. Although the move was anticipated for months, it still drove markets to new highs in the days that followed, as investors salivated at the prospect of more rate cuts through the end of this year and next.  

September has historically been the worst month for stocks — but not this time. September closed with the S&P 500 gaining 2%, the DJIA 1.9%, and the NASDAQ 2.7%. The 10-year Treasury yield rose to 3.77% from 3.62% prior to the rate cut, the opposite of what you’d expect. That’s because long-term rates aren’t only tied to short-term rates that the Fed is lowering; they also reflect long-term expectations for inflation and economic growth. There were market gains abroad as well. Monetary easing in China helped Chinese stocks gain more than 25% over the last five trading days. That in turn drove emerging market stocks to their best day of gains in over a year. 

Is it time for “Risk-On”? Not so fast. 

Investors today have high expectations that the Fed’s move in September is just the first of a cycle of rate reductions that will last through 2026. And for good reason. The dotted lines in the chart below indicate the Federal Open Market Committee’s (FOMC) participants’ median assessments of the appropriate path for the Federal Funds Rate going forward, based on the Summary of Economic Projections. It shows a nice, steady cycle of rate cuts until the Fed Funds rate is down below 3%.

But this cycle of rate cuts isn’t an automatic given. The Fed so far has predicated its actions on economic data — like decreasing inflation, steady employment, and economic growth. Experts expect a full rate cutting cycle, a nice, cushy soft landing for the economy. But if October’s jobs and inflation data disappoint, that could easily mean a much rockier path ahead. That coupled with the upcoming US presidential election likely means plenty of volatility and unexpected surprises. 

If the data continues to show progress, then yes, the Fed will likely continue to lower rates. But if inflation reverses and starts to tick up, the Fed could take a breath and pause on further rate cuts. Unlike the experts, I’m not counting my chickens just yet. 

In fact, when it comes to investing, I’ve learned that counting on anything as a given can lead to unexpected and unpleasant surprises.   

What should investors do now?

While I’m optimistic about the health of the economy (regardless of election outcomes), I’m also keeping a healthy dose of caution and humility in my back pocket. 

The worst kinds of market surprises occur when what you expect and feel so sure about doesn’t actualize. Historically, rate cutting cycles have come in response to an economy in trouble. (Think post-pandemic or global financial crisis.) But this time is different. The Fed has stated that this cycle is about normalizing monetary policy to keep the economy at a healthy equilibrium.  

As always, in the face of uncertainty (which is pretty much always the case for market behavior), our advice for long-term investors is to stay the course and keep your portfolio well-diversified. But if you’re one of those investors still sitting on excess cash and enjoying those juicy 5%-plus yields in money market funds, it might be time to think about putting that money to work. If the Fed’s recent rate cut is the beginning of a multi-year rate cutting cycle, King Cash may be forced to abdicate its crown. And even if rates don’t fall any further, historically, stocks and bonds have outperformed cash over many economic cycles. 

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Disclosures