What the Fed's Expected 2026 Rate Cuts Could Mean for the Stock Market

Interest rates are almost sure to fall this year. The Federal Reserve itself expects to ratchet down the benchmark fed funds rate by about 75 basis points in 2026, or three-quarters of 1 percentage point. Meanwhile, numbers from CME FedWatch suggest the market's betting on the same.

But what does this realistically mean for the stock market? Probably what falling interest rates usually mean for stocks -- it's bullish. Just don't ignore the unusual situation right now that poses some risk to this interpretation.

Walking a fine line

Most investors know the Federal Reserve helps maintain growth-inducing economic stability by using interest rates to accelerate or slow the economy, as well as to produce or reduce inflation (some inflation is actually healthy).

It's tricky though. Lower interest rates may spur new economic growth, but they also make it easier for inflation to develop. Conversely, higher interest rates curb inflation, but can also stifle the economy. The Fed walks a fine line.

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That's particularly true in light of recent economic reports. The Bureau of Labor Statistics says annualized consumer inflation currently stands at a palatable 2.7%, while the most recent look at the United States' GDP indicates impressive third-quarter economic growth of 4.3%, with Goldman Sachs predicting respectable GDP growth of 2.5% for all of 2026.

Connect the dots. The Federal Reserve doesn't necessarily need to lower interest rates this year. Doing so could arguably do more economic harm than good, which would ultimately undermine the market.

On the flip side, most people appear to be counting on these rate cuts whether we need them or not. Failure to implement them could shock investors into rethinking whether stocks are worth their risk right now, also undermining the market.

Bullish anyway

None of this risk appears to have discouraged the analyst community, however. Indeed, as Goldman also highlights, analysts still collectively believe the S&P 500 (SNPINDEX: ^GSPC) will end this year 12% above where it ended 2025, putting it somewhere in the ballpark of 7,670.

And it's not a bad bet in light of likely GDP growth as well as still-tempered inflation. Standard & Poor's agrees that the index's per-share earnings are apt to improve to the tune of 18%, led by the technology sector. Stocks won't necessarily become any more expensive than they are right now en route to the S&P 500's consensus target price.

The only potential rub? Even Goldman Sachs acknowledged in an article on its website: "The biggest risks to an equity market rally are weaker than expected economic growth or a hawkish shift [like a failure to lower interest rates as much as anticipated] by the Fed."

Even so, Goldman Chief U.S. Equity Strategist Ben Snider added, "Neither appears likely in the near future."

Bullish

Bottom line? You can never afford to turn your back on the market for very long, and that's especially true right now. These are strange circumstances to be sure.

But, the smart-money move here is to interpret this year's expected interest rate cuts in their most straightforward light. That's bullishly.

Just bear in mind this optimism leaves no room for disappointing GDP or earnings growth, which lower interest rates may not be able to quickly reverse should the need arise.

James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Goldman Sachs Group. The Motley Fool recommends CME Group. The Motley Fool has a disclosure policy.