Zacks Investment Management

The Fed Cuts Rates, But Remember What Really Moves Markets

The Federal Reserve cut rates by 25 basis points last week, a widely expected move that I would argue was priced into markets weeks, if not months, ago. Readers should expect the media and Fed prognosticators to spend the next several weeks debating the size and frequency of future cuts.

From an investment perspective, however, there are far better ways to spend your time.

I’d start by parsing the economic backdrop against which the Fed made its move. Last week brought a pair of reports that I would label as “stagflation-light.” Consumer prices in August accelerated slightly faster than expected, with core CPI rising 3.1% year-over-year. At the same time, labor market figures showed more weakness than previously thought. A major revision reduced payroll gains by nearly a million jobs from prior estimates, and August’s unemployment rate ticked up to 4.3%. Payroll growth slowed to a trickle, with June even registering a net job loss after revisions. A headline in the Wall Street Journal this week summed it up: “More Americans are Stuck with the Jobs They Can Get, Not the Ones They Want.”¹

Taken together, the view from 30,000 feet suggests that while the job market isn’t collapsing, the days of “goldilocks” balance, low inflation, and strong job growth, are clearly behind us.

This combination does not amount to stagflation in the 1970s sense, however, with runaway inflation and high unemployment. Instead, it looks more like stagnation: a slow patch where growth cools, inflation runs a bit hotter than policymakers would like, and businesses hesitate to make longer-term investments. Consumer spending is still positive, and business outlays on areas, like intellectual property and AI infrastructure, remain robust. This results in a picture of an economy experiencing ‘muddle-through’ growth—not great, but not dismal either.

Against this backdrop, the Fed’s quarter-point cut looks less like the start of an aggressive easing cycle and more like a recalibration. Policymakers appear to be acknowledging that tariff-related inflation pressures are likely a one-time shock rather than the start of a lasting upward spiral. At the same time, they are signaling an awareness that labor market weakness is mounting. The Fed’s updated projections will show just how seriously they are weighing those risks. But whether this cut turns into a series of cuts will ultimately depend on the data in the coming months.

For investors, the key point to come back to, in my view, is that monetary policy is not the main driver of stock prices. Earnings remain the heartbeat of equity markets, and here, the outlook is broadly supportive. With the Q2 reporting season effectively in the rearview mirror, S&P 500 earnings are on track to have risen +12.1% from a year earlier on +6.1% revenue growth. Looking ahead, Q3 earnings for the index are expected to climb another +5.1% on +5.9% higher revenues. Importantly, estimates have been revised upward in recent weeks, as seen in the chart below.

To be fair, the earnings picture remains top-heavy. Strip out Tech’s contribution in the coming quarter, and S&P 500 earnings growth would be closer to +2.1%. This unevenness raises the odds that actual results could disappoint relative to rising expectations, particularly in sectors under pressure like Medical, Transportation, and Basic Materials.

Still, the overall revisions trend is positive, which is not what you would expect if the economy were tipping into recession. Yes, the economy is slowing, and yes, tariffs are creating headwinds. But corporate America is still finding ways to grow, and earnings power is intact.

Bottom Line for Investors

Shifting the focus away from the Fed decision is not meant to totally diminish its significance. A lower policy rate can help steepen the yield curve and reduce some financing pressures, particularly in interest-rate-sensitive areas like housing or credit creation. But it would be a stretch to argue that one quarter-point cut will meaningfully change the economic cycle or override the market’s longer-term trend. The decision was telegraphed well in advance and priced in by investors weeks ago. That means the announcement itself carries little surprise power for markets.

More important is the economic backdrop, which I would characterize more as stagnation than stagflation. While policy uncertainty and weaker job growth may keep volatility elevated in the near term, corporate earnings remain the critical driver for markets, and the outlook for Q3 is encouraging at this moment.

Disclosure