The Federal Reserve (Fed) finally did it! At their September 16 and 17 meeting, the Federal Open Market Committee (FOMC) cut interest rates for the first time in 2025 by 0.25% (or 25 basis points). Although this rate cut was widely anticipated, it was what else the Fed had to say about future rate cuts that was of particular interest to the investment markets. After announcing the 25-basis point cut, the Fed indicated they are planning two additional rate cuts by the end of the year which came as great news to the market.
So how do investors adjust their portfolios to potentially profit in a declining interest rate environment? Although there are many ways, here are a few of the most commonly used ideas.
This could be a healthy environment for cyclical sectors, meaning sectors like technology, financials, and consumer discretionary, that tend to rise and fall in tandem with the economy. Historically, in non-recessionary environments, cyclical sectors have outperformed by 2 percentage points on average in the 12 months after the Fed started cutting rates. By contrast, defensive sectors like utilities, health care, and consumer staples have underperformed by 3 percentage points on average in such environments.
Small capitalization (cap) stock may also benefit. Since smaller companies typically have a more difficult time borrowing funds for operations and expansion than larger companies, lower interest rates may be of a greater benefit to smaller companies. Case in point – the Russell 2000 has shown a strong positive reaction to declining interest rates, with the index surging to a new record high following the Fed’s recent rate cut. Historically, small cap stocks have produced solid returns following the conclusion of a rate-cutting cycle, perhaps indicating the potential for continued gains as the market digests the easing of monetary policy.
As interests decline, investors in money market accounts and CDs may find the lower rates of return less attractive and begin to look for alternative investments that may produce higher rates of return and keep a lower risk profile. One possible investment that may benefit from lower rates is intermediate-term corporate bonds. “Intermediate” would mean maturities of four to six years, which to dedicated bond investors is considered the “belly of the curve.”
The rate of refinanced mortgages jumped 60% since the Fed cut rates in September. This is likely to revive an otherwise sluggish housing market by making borrowing for a home less expensive.
At this point, many analysts do not expect the U.S. economy to fall into recession although there is noticeable weakness in the labor markets. The Fed’s recent rate cut and anticipation for two additional cuts this year is intended to stimulate the economy, revive employment, and set the path forward for the economy to grow for the balance of 2025 and into 2026.