Federal Reserve rate cuts = U.S. stocks surge? There is an important precondition and a key indicator.

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Will US stocks surge after the Fed cuts interest rates? Barclays points out that this crucially depends on whether the economy falls into recession, and the unemployment rate is the key indicator for judging the economic trend, determining the stock market's performance after a rate cut.

On September 11, according to Chase the Wind Trading Desk, Barclays stated in its latest research report that historical experience on the stock market's direction after the Fed restarts rate cuts shows that stock performance depends entirely on whether the economy falls into recession. Research shows that among seven instances in the past fifty years where the Fed resumed rate cuts after a significant pause, four were accompanied by recessions and three saw continued economic expansion, with very different stock market results in each scenario.

The report notes that the market widely expects the Fed to restart the rate-cutting cycle next week, and market pricing suggests about six rate cuts in the next 12 months. In the absence of a recession, stocks steadily rise after a rate cut and hit new highs within six months, outperforming bonds. But if a recession occurs, the stock market usually continues to decline after a rate cut, though it rebounds after 12 months.

Barclays emphasizes that the unemployment rate becomes a key indicator distinguishing between these two scenarios (recession or economic expansion). Historical data shows that when a recession occurs, the unemployment rate continues to rise for nearly a year after rate cuts; when the economy continues to expand, the unemployment rate rises only slightly and starts to fall within a few quarters. Currently, the US unemployment rate has been steadily climbing, which is precisely the key factor prompting the Fed to consider cutting rates.

In addition, the bank also stated that the shape of the yield curve affects sector performance. Historically, a bull-steepening environment is most favorable to the stock market, while cyclical sectors perform best during bear-steepening periods. Barclays believes that if current rate pricing remains unchanged, a bull-flattening trend could persist and continue to support stocks.

Historical Review: Post Rate-cut Stock Performance Depends on Recession

According to Barclays statistics, among the seven major instances over the last fifty years when the Fed resumed rate cuts after a significant pause, recessions occurred after rate cuts in December 1974, November 1981, July 1990, and October 2008; while after those in December 1995, November 2002, and June 2003, the economy continued to expand.

In the absence of recession, the MSCI World Index's average returns at 1, 3, 6, and 12 months after a rate cut are 1%, 2%, 8%, and 17% respectively. In contrast, returns in recession scenarios were -2%, 2%, 0%, and 6%, clearly lagging behind.

Cross-asset performance also diverges. Without recession, stocks typically outperform bonds, with the S&P 500 up 16% over 12 months and 10-year Treasury yields essentially flat. In a recession, bonds perform better, yields rise 8%, while the S&P 500 12-month gain is only 12%.

Notably, if the economic cycle ultimately continues, the stock market always rises before a new round of rate cuts, but the reverse is not true. This shows that market expectations for the economic outlook are reflected even before rate cuts are initiated.

Unemployment Rate: The Key to Distinguishing Soft Landing and Recession

The direction of the unemployment rate becomes a crucial variable for judging the post-rate-cut economic path. Historical data shows that in a recession, the unemployment rate continues to rise for about a year after a rate cut, with a cumulative increase of 2–3 percentage points. In the case of continued economic expansion, the unemployment rate rises only slightly before and after rate cuts, then starts to fall within a few quarters.

Currently, the US unemployment rate has steadily risen from its lows to 4.3%, which is the main driver of market expectations that the Fed will restart rate cuts. Barclays economists expect that as the labor market slows significantly, the Fed may cut the federal funds rate from its current level to 3.0% by the end of 2026.

Leading indicators in the job market show that wage growth may further slow. Forward-looking indicators such as the ISM Employment Index suggest that job growth momentum will continue to weaken, but the US economic surprise index remains strongly positive, contrasting with the sharp lowering of rate expectations.

Economic activity indicators show a similar pattern. The ISM Manufacturing Index typically improves about a quarter after a rate cut in a no-recession scenario, but continues to decline for several quarters before bottoming and rebounding if a recession occurs.

Yield Curve Shape Determines Sector Rotation Direction

Different shapes of the yield curve have significant impacts on sector performance. Historical data show that the US 10-year vs. 2-year yield curve generally bull-steepens before a rate cut, with this trend even more pronounced in a recession.

After rate cuts resume, the yield curve splits: in a no-recession scenario, the curve modestly steepens for a few months after the rate cut, then flattens again. In recession, after initial steepening comes bear flattening, and about six months later as the economy recovers, it transitions to bear steepening.

In terms of sector performance, a bull-flattening environment is the most favorable for stocks, with the largest overall market gains and broad sector participation, slightly leaning toward cyclical sectors. Cyclical sectors perform best during bear steepening, but perform poorly during bear flattening and bull steepening periods.

Currently, the decline in US real rates is the main driver of falling yields, rather than changes in inflation expectations. Historically, lower real rates benefit short-cycle sectors such as capital goods, durable consumer goods, chemicals, building materials, autos, mining, and transportation.

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