Will the Fed let the stock market down?

Stocks are higher again on Thursday, and although gains are fairly mild so far, the scene is set for a year-end rally. There seems to be one main driver for stocks this year: an increase in expectations of a Fed rate cut next week.

The Fed Fund Futures market is now pricing in a 98% chance of a cut next week. It is the Fed’s black out period, so there is no chance for FOMC members to push back on this narrative ahead of next Wednesday’s meeting. There has been a small recalibration in rate cut expectations in the past month. From now until June 2026 there are 2.5 rate cuts priced in by the market, a month ago two cuts were priced.

No change to future cut expectations, which could lead investors disappointed

Thus, even though markets are rallying on the back of next week’s rate cut, there hasn’t been much change in expectations for future rate cuts. If/ when the Fed cuts rates next week, what comes then? Unless the Fed signals that they will cut rates at a faster pace than expected, we could see risky assets pull back. Some analysts think that we could get a ‘hawkish cut’ from the Fed next week, so are markets setting themselves up to fail?

Bond market fails to join in with stock market rally

Hopes that the Fed will make a dovish pivot after Jerome Powell’s term as Fed chair ends next May is also fueling this rally. However, the bond market’s reaction is worth watching. In the past month, US yields have barely budged. The 10-year  Treasury yield has risen by 0.7bps, even though Fed rate cut expectations have risen. This suggests that bond investors are not welcoming a potential dovish Fed chair with as much enthusiasm as the stock market. This is a theme to watch out for in 2026, especially if inflation is reignited on the back of tariff passthrough.

Can the S&P 500 reach 7,000 by year end?

When the bond market does not join in a rally, it is worth paying attention. The recent rally in US stocks has been enough to push the S&P 500 to just 70 points from its record high. It appears that concerns about sky high valuations have been put to bed, and US stock price valuations are getting higher as we move to the end of the year. The average price to earnings ratio of the S&P 500 is now 27 times earnings, well above the average of 22 for the last ten years.

The shift in the Fed rate cut expectations are essentially neutral for stocks: the near-term cut has not made further cuts more likely. However, prospects of a near term Fed rate cut have been enough to placate investors to finish the year on a high, but there are plenty of risks out there including a stronger than expected PCE reading for the US on Friday and a hawkish Fed next Wednesday. However, on balance, we think that the S&P 500 could end the year above 7,000, with fears about valuations pushed out to 2026.

UK: the FTSE 100 could benefit if the gold rally continues

Two interesting developments have happened for UK equity markets recently. Firstly, the materials sector, which includes top performing gold miners, is now bigger than the energy sector. If the gold price continues to rally into 2026, then this trend may continue. Secondly, although UK investors pulled out a combined £6.6bn from UK equities since October, the most on record, there are signs that flows are stabilizing. This accounts for the UK stock market under performance in the past month, the FTSE 100 is lower by 0.02%, compared to a 1.1% gain for the Eurostoxx index. However, if flows have now stabilized, the mix of non-tech-related stocks in the UK index could be enticing for investors, especially since the FTSE 100 also has an attractive valuation at 14.64 times earnings.

Overall, we think that the market will attempt a three-day winning streak for stocks, as we lead up to Friday’s Core PCE report from the US.