Rate cut expectations drive markets to new highs

US markets have been hitting record levels this week, and the catalyst of growing conviction that the Federal Reserve will cut rates in September.

The Dow surged 463 points on Wednesday, the S&P 500 notched another all-time high, and the Nasdaq also finished at a record for the second straight day.

The optimism is being driven by a tamer-than-expected inflation report that has traders assigning a near 100% probability to a rate cut at the Fed’s next decision. Add in a resilient earnings season, with even small caps showing renewed strength, and you have a market rally that is no longer confined to the usual megacap tech leaders.

When the cost of borrowing falls, capital becomes cheaper for companies, financing becomes less of a drag, and equity valuations tend to expand.

Lower rates also give consumers more room to spend, which can ripple quickly through corporate revenues.

This is why rate expectations are such a potent driver of equity markets, and why we’ve seen the rally broaden beyond the so-called ‘Magnificent Seven’ to small- and mid-cap stocks, with the Russell 2000 gaining 2% on Wednesday alone.

But this is not just a US story. The US is still the primary engine of global capital markets, and when Wall Street moves, liquidity, sentiment, and valuation re-rating tend to spill across borders.

Emerging market equities, for example, often benefit disproportionately when US rates come down – capital flows in search of higher yields and growth potential can accelerate. Developed market exporters, particularly in Europe and Asia, can also see upside if a weaker dollar boosts their competitive position.

The near-term picture, if the Fed does deliver in September, is a global risk-on environment. Equities would likely extend their gains, credit spreads could tighten, and certain currencies sensitive to growth and risk sentiment, such as the Australian dollar or the South African rand, may strengthen. Commodities tied to industrial activity, including copper, could get a boost as the growth narrative firms.

Of course, markets rarely move in straight lines. The risk is that optimism runs ahead of reality, especially if economic data turns quickly or if central bankers signal that cuts will be more measured than investors hope.

Inflation, while easing, has not disappeared, and the Fed will want to avoid the perception that it is acting too aggressively.

For investors, this is a moment that demands both clarity and discipline.

The broadening of the rally is a healthy sign – it suggests that markets are no longer reliant on a small cluster of giants – but it also means that opportunities are appearing in areas that have been overlooked for much of the past year. This includes sectors and regions that stand to benefit directly from a lower cost of capital and a potential reacceleration in global trade.

It also calls for an awareness of currency implications.

A Fed rate cut would likely weaken the dollar, which could enhance returns for non-US assets in dollar terms, but it could also introduce volatility in foreign exchange markets. Investors with global exposure need to understand how this might affect both portfolio performance and risk.

We are entering a period where positioning ahead of policy moves can have a material impact on outcomes. The market is already pricing in a September cut – which means the real opportunity lies in anticipating how capital will reallocate once that cut is delivered.

It’s a question of identifying the sectors, asset classes, and geographies best placed to benefit in the first phase of easier policy, while also protecting against the possibility of a bumpier path than markets currently expect.

The Fed’s next move is not just about rates. It’s about resetting the tempo of the global financial system after two years of aggressive tightening. As always, such a reset will create winners and losers – and the difference between them will come down to preparation.