What Drove the Stock Market's Record-breaking Week? Don’t Overlook Growing Rate Cut Expectations

U.S. stocks soared on Friday, with the S&P 500 hitting a new intraday record, as investors grew increasingly confident that the Federal Reserve will cut interest rates at least three times before the end of 2025. The rally was fueled by a sharp shift in expectations among traders regarding monetary policy, alongside improving economic signals and easing geopolitical tensions.

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According to the CME FedWatch Tool, the odds of the Fed delivering three or even four quarter-point cuts by December have climbed to 56.3%, up from 30.8% just a week earlier.

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These rate reductions would bring the central bank’s benchmark interest rate down to a target range of either 3.5%–3.75% or possibly as low as 3.25%–3.5%. If realized, that would represent more easing than the Fed itself suggested just last week.

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A key factor driving this shift is speculation that President Donald Trump may announce his pick for a new Federal Reserve chair as early as September or October — months ahead of the scheduled end of Jerome Powell’s term in May next year.

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Trump’s likely choice is expected to favor a more accommodative stance and could begin influencing market sentiment even before officially taking over, potentially acting as a “shadow” Fed chair.

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Adam Turnquist, chief technical strategist at LPL Financial, noted that Friday’s movements in both equities and Treasurys were partly influenced by the growing belief that a new, more dovish Fed leader could be announced soon.

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“While Powell is still in charge until next year, markets are starting to factor in this potential leadership change,” Turnquist said in a phone interview. “But it’s not just about the Fed — it’s also about a broadening sense of optimism around the economy.”

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That optimism stems from several fronts. Inflation appears to be cooling, trade relations are improving, and geopolitical tensions — particularly in the Middle East and Eastern Europe — are de-escalating. These developments support hopes for a “soft landing,” where inflation declines without triggering a recession, making current interest rate levels seem overly restrictive.

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In his testimony to Congress earlier in the week, Powell acknowledged that recent economic indicators could already justify rate cuts — if not for the risk that tariffs might reignite inflation. However, data released Friday showed no significant tariff-driven inflation. In fact, the Fed’s preferred inflation gauge, the personal consumption expenditures (PCE) index for May, remained stable. Additionally, consumer spending unexpectedly declined last month, which further supports the case for easing monetary policy.

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Adding to the momentum was Fed Governor Christopher Waller, who on CNBC last Friday became the first member of the central bank’s leadership to openly endorse a rate cut as early as July. Fellow Governor Michelle Bowman followed suit on Monday, saying in a speech in Prague that she would be open to lowering rates as soon as next month.

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Chris Low, chief economist at FHN Financial in New York, argued that the Fed’s current policy stance is “unnecessarily restrictive” and is putting strain on the economy. “The restraint is taking a harsh economic toll,” he said, echoing the views of a growing number of market participants who believe the central bank should act sooner rather than later.

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Friday’s market response was broadly positive. All three major stock indexes posted gains, with the S&P 500 climbing 0.65%, the Dow Jones Industrial Average rising 1.13%, and the Nasdaq Composite advancing 0.58%. The S&P 500 set a new intraday record of 6,187.68, surpassing its previous high of 6,147.43 reached on February 19.

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In the bond market, Treasury yields were mostly unchanged despite the shifting expectations for rate cuts. The yield on the 2-year note — which is particularly sensitive to Fed policy — ticked up slightly to 3.73%, but still remained close to levels seen in April and May. The 10-year yield barely moved, reflecting a broader market consensus that inflation risks are subsiding.

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Break-even inflation rates, which signal investor expectations for future inflation, also held steady. Turnquist interpreted this as a sign that markets are increasingly confident tariffs will not have a major long-term impact on inflation. “Markets are effectively brushing off the short-term noise,” he said. “They’ve already priced out the worst-case scenarios tied to trade and geopolitical risks.”

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Turnquist added that the modest uptick in the 2-year yield didn’t concern him. “The trend is still pointing lower,” he said. “I wouldn’t be surprised to see it retest the April or May lows around 3.6%.”

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In sum, Friday’s record-setting performance in equities reflects a complex but increasingly optimistic picture. Investors are betting that interest rates will soon decline, inflation will stay under control, and global tensions will continue to ease. If those bets pay off, the second half of 2025 could offer a more supportive environment for financial markets — especially if the Fed takes action sooner rather than later.

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