Why does the US stock market care so much about interest-rate cuts?

Only a few weeks ago, the US stock market stumbled on fears of a potential bubble in AI-related shares. Now, equities are once again approaching record highs — and much of that momentum is being driven by the Federal Reserve.

Stocks rebounded from their early-November pullback as investors increasingly bet that the Fed will cut interest rates this week in its final meeting of the year.

Rate cuts can support equities by reducing borrowing costs for consumers and businesses, lowering returns on savings, and encouraging spending and investment. That, in turn, boosts economic activity and corporate earnings.

Lower interest rates also reduce yields on short-term government bonds and cash-like instruments such as money-market funds, making higher-returning assets — like equities — more attractive.

In general, interest-rate cuts can create a strong tailwind for the stock market.

Jonathan Krinsky, chief market technician at BTIG, wrote in a Monday note that the market’s recent rally has coincided with rising expectations of a December rate cut.

Traders on Monday were pricing in an 89% chance of a cut, according to CME’s FedWatch tool.

Krinsky added: “Markets have essentially erased the weakness seen in November… and that reversal has almost exactly tracked the increase in December rate-cut odds.”

Lower rates can provide meaningful support for stocks

The Fed is considering a rate cut in response to concerns about a weakening labor market. But for investors, lower rates act as fuel for further stock-market gains.

The Fed’s benchmark rate influences a wide array of borrowing costs across the economy. A cut would reduce financing expenses for many companies.

The Russell 2000 index — which tracks smaller, more rate-sensitive firms — hit a record high on December 4.

José Torres, senior economist at Interactive Brokers, said: “If you look at smaller, more vulnerable companies like those in the Russell 2000, lower rates significantly reduce their financing burden, expanding their profit margins. That’s why sectors like real estate, manufacturing, and small business benefit the most from lower rates.”

That said, even as investors welcome the near-term cuts expected this week, Wall Street is always looking ahead — and uncertainty remains over the pace of future easing in January.

On Wednesday, the Fed will release its quarterly Summary of Economic Projections, which includes policymakers’ anonymous forecasts for the interest-rate path over the coming months.

Jason Pride, chief of investment strategy and research at Glenmede, wrote: “While the Fed may consider further cuts this week and into 2026, any renewed acceleration in inflation will likely force a slower and more cautious path.”