Will the Fed’s December 2025 Rate Cut Really Boost the S&P 500?

The Fed’s first rate cut of December 2025 is widely expected. Here’s how it may shape the S&P 500, Nasdaq, and US investor strategy going into 2026.

As the December 2025 FOMC meeting approaches, investors find themselves navigating one of the most consequential policy moments of the year. The Fed is widely expected to deliver a 25 bps rate cut—the third step in an easing cycle that began earlier in the fall—and futures markets now assign nearly a 90% likelihood to that outcome.

Yet the rate decision itself is no longer the central question. The S&P 500 sits near all-time highs, supported by strong earnings from mega-cap tech, improving sentiment around a soft landing, and expectations that lower rates will continue to support risk assets. This leaves investors wondering whether the upcoming cut will ignite another leg of the rally or simply confirm what markets have already priced in.

To understand how the S&P 500 and Nasdaq may react, it helps to examine what the market already expects, how stocks have historically behaved after the first rate cut, and why this particular cycle differs from earlier ones. From there, three clear scenarios emerge—each carrying different implications for US investors managing exposure heading into 2026.

What Markets Have Already Priced In

Although the December meeting is receiving intense attention, the rate cut itself is not controversial. Futures markets and rate-monitor dashboards consistently show that traders expect the Fed to move forward with a 25 bps cut. The level of certainty is high enough that investors now look past the rate decision to the tone and outlook the Fed will present for 2026.

What markets truly want to know is whether December represents the beginning of a meaningful easing cycle or simply a single adjustment in response to a cooling labor market. The answer will shape not only interest rates next year but also the valuation environment for equities and the behavior of the US dollar.

As the meeting approaches, equity markets have stalled just below record levels, reflecting both optimism and caution. Meanwhile, the dollar has steadied after earlier weakness as traders consider the possibility that the Fed may not commit to substantial easing beyond December. This dynamic sets the stage for a rate cut that matters less on its own and more as a signal of what the Fed intends to do next.

What History Says About the First Rate Cut

Historical data highlights a key truth: rate cuts are not inherently bullish or bearish. Their impact depends heavily on the state of the economy at the moment the Fed begins to ease.

In cycles such as 1995, 1998, and 2019, the Fed cut rates preemptively, aiming to extend economic expansions. In each case, the S&P 500 delivered strong double-digit gains over the following year. These periods were defined by solid labor markets, manageable inflation, and growing productivity.

By contrast, in 2001 and 2007, the Fed began cutting in response to emerging recessionary pressures. Despite multiple cuts, the S&P 500 declined sharply as underlying fundamentals deteriorated faster than monetary policy could respond. Rate cuts did not arrest the downturn—they accompanied it.

When looking across all cycles since the 1970s, the S&P 500 shows a median one-year gain of around 14% after the first cut and a positive outcome roughly 70% of the time. But the dispersion of outcomes is wide, and the worst performances occurred when rate cuts were delivered too late.

This distinction makes the December 2025 meeting particularly important. Whether the upcoming cut resembles the soft-landing cuts of the 1990s or the late-cycle cuts of the early 2000s may determine the S&P 500’s trajectory over the next 12 months.

Why the 2025–2026 Cycle Is Unlike Earlier Ones

While history offers guidance, the current environment introduces complexities that do not neatly align with past patterns.

1) The First Cut Arrives Near Market Highs

The S&P 500 is entering the rate cut with valuations already elevated. Earnings resilience and enthusiasm around AI-driven productivity have pushed multiples higher, leaving less room for disappointment. Unlike earlier cycles in which rate cuts initiated multi-year expansions, this cut arrives at a moment when the market has already seen a strong rally.

2) Inflation Has Improved, but the Job Is Not Finished

Inflation has cooled considerably from its post-pandemic peak, but it has not yet returned to the Fed’s 2% target. This complicates the Fed’s communication strategy. Offering an overly dovish message risks re-igniting inflation expectations, while a cautious tone could restrain equity enthusiasm. The central bank must strike a balance that protects credibility without shocking markets.

3) Labor Market Conditions Are Softening, Not Cracking

The US labor market shows signs of moderating—job openings have fallen, hiring has slowed, and wage pressures have eased—but the data does not signal a recession. This creates a narrow policy window for the Fed: ease enough to support growth, but not so aggressively that inflation risks return.

For investors, this mixed environment suggests that the December cut is better interpreted as fine-tuning rather than a decisive pivot.

What the First Rate Cut Means for Stocks, Bonds, and the Dollar

US Equities: Balancing Growth and Quality

Growth stocks typically benefit from lower discount rates, while quality stocks with strong cash flows offer resilience during periods of uncertainty. In the early stages of easing cycles, both styles can perform well, but valuations limit upside in mega-cap growth.

Small caps, meanwhile, may benefit from improved financing conditions if the cut is interpreted as the beginning of a steady easing cycle. But their performance is highly sensitive to how confident the Fed sounds about the 2026 economic outlook.

Bonds: Duration Matters More Than Usual

If the Fed signals further easing ahead, longer-duration Treasuries could see meaningful rallies as yields fall. Investment-grade credit may also strengthen.
However, a hawkish tone could steepen the yield curve and pressure high-yield credit, which remains sensitive to growth uncertainty.

Dollar and Gold: A Story of Expectations

The US dollar has stabilized recently, suggesting that currency traders expect the Fed to ease cautiously. Gold, traditionally supported by lower real yields, may rally if the Fed sounds more dovish than expected. But a neutral or hawkish message could limit gains.

Three Scenarios for US Investors After the December Rate Cut

Scenario 1: A Dovish Cut

The Fed delivers a 25 bps cut and signals additional easing in 2026.
This would likely reinforce soft-landing expectations and support risk assets.

Market impact:

• S&P 500 and Nasdaq could reach new highs.
• Growth, AI, and small caps may lead.

Investor stance:

• Overweight growth and quality growth ETFs.
• Maintain exposure to broad US equity indices.

Scenario 2: A Neutral Cut

The Fed cuts but emphasizes data-dependence and avoids committing to future moves.
This is currently the most plausible scenario.

Market impact:

• Short-term volatility, followed by a gradual recovery.
• Sector leadership rotates, with emphasis on quality and earnings stability.

Investor stance:

• Blend growth, quality, and dividend strategies.
• Selectively add small caps.

Scenario 3: A Hawkish Cut

The Fed cuts while warning that inflation risks remain too high for additional easing.
This outcome could trigger a “rate-cut sell-off.”

Market impact:

• High-valuation growth stocks may correct.
• Defensive sectors outperform.

Investor stance:

• Increase allocation to Treasuries and investment-grade credit.
• Rebalance toward defensive equity exposures.

The December 2025 rate cut is almost certain, but its meaning is not.
Whether it launches a new phase of the easing cycle or simply acknowledges a cooling labor market will shape the S&P 500’s direction into 2026.

History shows that rate cuts can support equities, but only when the underlying economy cooperates. With valuations high and inflation still above target, investors should avoid assuming that easing alone guarantees a rally.

Instead, preparing for multiple outcomes—and positioning portfolios around growth, quality, value, and bonds—offers a more durable approach as the Fed begins its first rate cut of this cycle.

References

• Reuters – US stocks end lower as investors wait for Fed rate decision
• Reuters – US dollar firms on expectations of limited Fed easing
• Reuters – Dollar slips as traders eye next week’s Fed meeting
• CME Group – FedWatch Tool: Probabilities of FOMC rate moves
• Investing.com – Fed Rate Monitor Tool