What impact will the Federal Reserve’s rate cut have on stocks?

U.S. stocks leapt to record heights Wednesday before moderating their gains as the Federal Reserve delivered an interest rate cut on the bigger side of expectations, reducing its benchmark rate by 50 basis points.

Little changed in trading Wednesday ahead of the central bank’s action at 2 p.m. Eastern time, in the wake of which equities surged, with the Dow Jones Industrial Average jumping more than 200 points to a new record before dialing back on its gains, up 154 points, or 0.4% as of 3 p.m.

The decision by the Federal Reserve’s policy-setting committee to cut interest rates for the first time since 2020 was prefaced by an unusual amount of market uncertainty as to how much the Fed would lower its benchmark rate from a two-decade high of 5.25% to 5.5%, where it has stood since July 2023. 

Art Hogan, chief market strategist at B. Riley Wealth Management, said the Fed’s messaging is more important than the exact size of its cut, as the central bank embarks on what is likely to be a series of reductions through this year and next. “Whether it’s a quarter or half a point, it’s much more about where they are going and when are they going to stop,” Hogan told CBS MoneyWatch. 

Short-term impacts aside, the Fed’s move is largely seen as positive for the economy as well as for the broad stock market.

“We anticipate that these Fed cuts should have a positive effect on the economy and markets in 2025. We believe the global economy is likely to benefit as well, as major central banks around the world have already cut rates or are on the verge of doing so,” Scott Wren, senior global market strategist at Wells Fargo, said in a note.

“Market environments with declining rates and rising profits tend to be supportive of equity prices,” according to John Lynch, chief investment officer for Comerica Wealth Management. “A few cuts are welcome, more cuts would be troublesome,” Lynch said. 

Expectations of Fed rate cuts have had investors shifting gears and gravitating toward public companies that are interest-rate sensitive, including dividend stocks, telecoms, consumer staples, utilities and real estate investment trusts, Hogan offered. 

Public companies with smaller market capitalization are likely to draw more interest in an environment with falling interest rates and steady economic growth, according to Hogan, who pointed out that the segment is well-priced, given its relative underperformance.

“You’ve got the ingredients for a rally in small caps,” said Hogan.

Bringing down interest rates should drive some much-needed inventory out of existing home sales and fuel economic activity. 

Reductions in short-term interest rates should be a boon for dividend-paying stocks, particularly in the financial sector, as lower rates reduce the cost of funding for banks. Other beneficiaries include public companies that would benefit from cheaper debt financing and lower interest rates. 

Real estate stocks are also likely to benefit as lower rates reduce borrowing costs for buyers. 

The Fed’s rate cut and messaging is directing Wall Street’s concerns toward jobs and away from higher costs. “We are less concerned about inflation and more concerned about a soft landing in the labor market,” said Hogan.