The Federal Reserve (“Fed”) cut interest rates 0.25%-points at their September meeting last week, taking their policy rate to the 4.0–4.25% range. This comes after a long nine-month pause but the move was widely expected, especially given recent data showing a rapidly cooling labor market.
Not surprisingly, the widely anticipated cut was accompanied by more new highs for the S&P 500 Index, which climbed 1.25% last week to push it to a total return of 14.39% year to date. But we also saw a new all-time high for the Russell 2000 Index of small cap stocks, something that hasn’t happened since November 2021.
While this market continues to be led by technology-oriented large cap stocks, we think that small cap stocks making a new all-time high provide some nice confirmation of the broad market trend. Yes, large caps have been leading and that leadership has been concentrated, but broad participation in market gains matters, and we’ve been seeing that not only in small caps, but also international stocks this year. That tells us that should those big tech names falter, there are other areas of the market that can take up the torch.
So now that the Fed is cutting again, what’s the next thing to worry about? From what we’re hearing, it’s the possibility of a government shutdown at the end of the month, but historically that’s rarely been a problem for markets. Congress has until the end of the month to fund the government or we could be looking at the first shutdown since late 2018/early 2019. The odds of a shutdown are slowly increasing each day, but we have been able to avoid some shutdowns the past few years, specifically in the fall of 2023 when one was widely expected.
With all the negative headlines, does Congress really want to delay sending checks to veterans? We don’t know, but this is something we will watch very closely over the next week.
The good news is history says shutdowns have little to no effect on stocks. In fact, the last shutdown, in 2018–2019, was a record 34 days and stocks gained more than 10%! Most shutdowns last only a few days, so just enough to get in the headlines and then it is over just as quickly.
Below is a table we put together that shows how stocks have been up just a little on average during the previous 22 shutdowns (which are usually short), but a year later have been higher 19 times and up an average of nearly 13%. Yes, each time is different and we would never suggest investing based on what the government does (or doesn’t do). But it is important to remember not to worry too much about your investments based on the dysfunction out of Washington.
The Fed Cut, but What Comes Next? Look to 2026
The Federal Reserve (Fed) cut rates 0.25%-points at their September meeting last week, taking their policy rate to the 4.0–4.25% range. While investors did not expect an extra-large 0.5%-point cut (fed funds futures markets priced that at a less than a 10% probability before the meeting), it was notable that Fed Chair Powell was quite dismissive of the possibility, saying there was no widespread support for anything more than a 0.25%-point cut. This in a nutshell captured the dynamics of how the Fed is thinking about this rate cut.
The Fed has two mandates—maximum employment and stable inflation—and things are going in the wrong direction on both sides. Payroll growth data is flashing a big red warning sign, but inflation is also rising and running closer to 3%, well above the Fed’s target of 2%. So, there are risks to both sides of their mandate and the big question for the Fed has been, which one would they focus on?
Powell called the cut a “risk management” move, and given they chose to cut rates, they’re clearly prioritizing the risk to the labor market over inflation. In other words, the Fed is more worried about the labor market deteriorating more rapidly than inflation spiraling out of control. In fact, they believe inflation risk has eased since early summer. Current elevated inflation numbers are due to tariffs but that will be transitory. (Powell was careful about avoiding this word, but that’s essentially what he meant.)
The Fed also updated their quarterly projections of future GDP growth, inflation, the unemployment rate, and their expectations for the policy rate (the “dot plot”). For 2025, the median Fed member projected two more cuts (0.25%-points each), which would take the policy rate to the 3.5–3.75% range. Relative to their June economic projections:
- The core inflation (ex. food and energy) estimate for 2025 stayed unchanged at 3.1% (actual core inflation is currently at 2.9%).
- The unemployment rate estimate for 2025 stayed unchanged at 4.5% (currently at 4.3%).
- The real GDP growth estimate for 2025 was revised up from 1.6% to 1.8%.
Cutting rates by a total of 0.75%-points (including the September cut) over three months while revising their estimate of growth higher and expecting inflation to remain well above their target is a clear sign that the Fed is more worried about risks to the labor market.
They expect to cut rates one more time in 2026 (another 0.25%-points), even as core inflation is estimated to remain hot (they raised the 2026 inflation projection from 2.4% to 2.6%). By itself, that should also be a big tailwind for equity markets.
No Consensus on the Rate Outlook
What you see above is the “median” expectation for rates in the projections. The problem is that the 19 members of the Fed are all swimming in different directions. For 2025:
- Six members expect no more rate cuts this year.
- One member expects to raise rates again by 0.25%-points!
So, 7 of 19 members, a fairly significant portion of the committee, think nothing more should be done with policy rates this year.
On the other hand, 2 members think rates will be cut one more time this year, and another 9 believe two more cuts are forthcoming in 2025, which is why the median estimate was for two more cuts. That’s 11 of 19 members who think more action will be needed to protect the labor market and probably believe inflation risks have eased (we imagine Powell’s in this camp).
Interestingly, one member expects a whopping 1.5%-points of rate cuts this year, i.e. 5 more cuts of 0.25%-points each! We’ll take a closer look at this outlier below.
The dispersion across members is even more stark when it came to 2026 expectations, with the expected policy rate ranging from a low of 2.6% to 3.9% (we’re around 4.1% now after yesterday’s cut).
The lack of clear consensus within the committee is why Powell wasn’t ready to commit to continued policy rate easing over the next several months. Instead, he implied that the September cut was an insurance cut (to protect the labor market) and said they’re going to consider any further changes meeting by meeting based on interim data.
But none of this may matter as far as 2026 is concerned.
One Dot To Rule Them All—The Only Dot That Matters?
As noted above, there was an outlier dot when it came to 2025 rate expectations, with one member expecting rates to be cut several more times this year, taking the policy rate to 2.9%. Here’s the dot plot from the Fed’s own materials (the annotation added):
It isn’t hard to guess who this was—newly appointed Fed Governor, Stephen Miran. Miran was the Chair of the Council of Economic Advisors until Monday and passed Senate confirmation for the Fed Board seat just in time to make it to the Fed meeting that started Tuesday. Yet, this is only a temporary appointment until January. (President Trump could re-appoint him, but he’ll have to go through Senate confirmation again, and Miran hasn’t resigned from his CEA position (he’s on leave)). Safe to say, Miran is clearly the administration’s voice on the Fed Committee, and made his presence felt immediately.
It also gives us a clue as to what may be coming in 2026, which is what matters now. The President gets to appoint Chair Powell’s successor (Powell vacates his Chairmanship in May), and perhaps another governor. Combined with two other governors that were appointed by President Trump in his first term, there’ll likely be enough people at the Fed to push policy rates in the direction favored by the administration, i.e. lower, much lower. Even in the dot plot, you can see that five members already expect the policy rate to go below 3.0% by the end of 2026.
This is why markets are probably pricing a few more rate cuts in 2026 than the median Fed dot. Markets expect the policy rate to fall below 3% by 2026, versus the dot plot median of 3.4%.
What’s interesting is what comes after, which is a big disconnect in the opposite direction, with markets more hawkish than the Fed. The median Fed member expects rates to move closer to 3% in 2027 and stay there in 2028 and beyond, presumably as they expect inflation to hit their target and the unemployment rate to stay low. In contrast, the market expects the Fed to start raising rates again—likely because inflation becomes a problem—though markets probably believe the Fed will act on it only as President Trump’s term in office nears its end in 2028.
Markets may have this completely wrong but it’s not a stretch to imagine that inflation starts to become a bigger problem next year (it already is elevated) if the Fed pulls rates all the way down to 3%. That’s going to boost cyclical areas of the market, including housing. If Fed rate cuts pull mortgage rates down to 5%, expect a flurry of refinancings and even homeowners tapping into home equity (which there is plenty of because of rising home values over the last several years). There’s “fiscal stimulus” for households not in place too:
- A tax deduction on tips
- A tax deduction for seniors—$6,000 for an individual, and $12,000 for spouses filing jointly
- A much larger SALT (state and local tax, including property tax) deduction, with the limit rising from $10,000 to $40,000, which will benefit upper middle-income households who itemize their taxes
All of this is retroactive for 2025, which means several million households will receive larger than normal tax refunds. Just take the SALT deduction. Increasing the limit by $30,000 means taxes for a household in the 24% tax bracket will fall by $7,200 (if they have sufficient state and local tax deductions).
Now some of this will be offset by lower income for savers who were used to earning a 4%+ yield on their savings/money market accounts. But even there, we may see a movement out of these accounts into riskier assets (like longer-term bonds) to boost expected returns. That’s a positive for risky assets.
All this is likely to fuel spending and boost demand for risk assets generally, but this obviously raises the question, what about inflation? Well, it’s likely to remain elevated as well, running closer to 3% rather than the Fed’s target of 2%. But in the eyes of the administration, and the Fed, that may be a small price to pay to keep growth humming. And that may be what we see as 2026 kicks off: a period of inflationary growth. But that is also a strong environment for profits, and bullish for stocks.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly traded companies from most sectors in the global economy, the major exception being financial services.
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
Compliance Case # 8416695.1_091525_T_C
