Rate cuts to boost equity market returns

How quickly things can change.

Before answering that question, it is important to remember that volatility is all part of investing in the equity market. To achieve the power of compounding, an investor must tolerate downside risk.

• 3 corrections of 5% per year

• 1 correction of 10% per year

• 1 correction of >20% once every 6 years

For investors in equity markets, volatility is the price of admission for long-term gains.

The reasons economic growth will remain resilient

1. INTEREST RATES CUTS ARE COMING

If market pricing is correct, the US Fed Funds rate will fall to 3.50% (currently 4.33%) and the RBA Cash Rate will fall to 2.90% (currently 4.10%) by April 2026.

Historically, there is a good relationship between lower oil prices and G7 GDP growth rates. Big oil price increases have usually preceded recessions, as households respond to higher petrol prices by tightening their belts. In addition, central banks tend to raise interest rates to stem rising inflation. 

Conversely, GDP growth usually responds to lower oil prices after about 18 months, as consumers are spending less on their fuel bills and are free to spend more of their income on goods and services. For central banks, inflation is less of an issue in a falling oil price environment, meaning monetary policy can be run at a more accommodative level.

Labour markets in advanced economies today are among the tightest in two decades. The decline in unemployment rates post-Covid reflects a long-term trend that could continue as workforces age. In Australia, the unemployment rate has hovered around 4.1%–4.2% in early 2025, near 50-year lows, supported by record-high participation rates (67.3%) and robust job creation, particularly in government-related sectors such as healthcare, education, and public administration.

Additionally, demographic trends such as an aging workforce and steady immigration flows are tightening labour supply, further supporting employment levels and wage gains, and contributing to the overall resilience of the labour market.

The Trump administration appears likely to deploy stimulus in the form of individual tax cuts, which should increase the fiscal impulse and help fuel economic growth. Fiscal stimulus has been a strong component of US economic growth in recent years on the back of the Inflation Reduction Act and the CHIPS Act.

Since his return to the White House, President Trump has frequently announced intentions to make swift changes across the board, including the federal tax system. Congress is already working on legislation that would extend and expand provisions of the sweeping Tax Cuts and Jobs Act (TCJA), as well as incorporate some of Trump’s tax-related campaign promises.

The Tax Foundation estimates that permanently extending the expiring individual, estate, and business tax provisions would boost after-tax incomes by 2.9% in 2026 on average. The top 20% of income earners would see a 3.3% increase on average, while the bottom 20% would see a 2.8% increase on average.

In Australia, household balance sheets are in rude health. Total household assets reached $19.1 trillion in December 2024. Around 55% of this wealth is held in property, which is valued at $11 trillion. Other significant categories include superannuation at $3.9 trillion, and household deposits at $1.8 trillion. House prices and superannuation assets – such as Australian and global equities – are likely to find a supportive environment if growth remains resilient and interest rates are reduced.

Good equity market returns occur when growth is solid and central banks are cutting

This is the key question that investors should ask themselves. The economic context that is causing central banks to cut interest rates is as critical as their timing.

Using global economic cycles of the past 50 years, it is possible to look at the performance experience of rate cutting cycles that were associated with prior expansions.

Equity market performance during expansions and rate cuts

When central banks cut interest rates during economic expansions, stock markets often rise for several important reasons. A rate cut in the absence of a crisis is usually seen as a positive, forward-looking move. It suggests that policymakers want to keep economic momentum going by making it easier for businesses and consumers to borrow money. For companies, lower interest rates reduce the cost of taking out loans, which means they can invest more in new projects, hire more workers, and expand their operations. For consumers, lower rates make it cheaper to buy homes, cars, or other big-ticket items, which increases overall spending in the economy. This extra spending helps businesses earn more money, boosting their profits and making their stocks more attractive to investors.

How have equity market factors performed when interest rates are cut?

A good time to allocate

Whilst tariffs, uncertainty, and concerns have shook investors recently, the combination of interest rate cuts, resilient labour markets, and supportive fiscal policy creates a favourable environment for equity market returns over the coming twelve months. As central banks respond to easing inflation pressures and shifting growth dynamics, lower rates should help sustain business investment and household spending, while also improving the outlook for corporate earnings. 

Historical data shows that equity markets have consistently performed well following expansionary rate cuts, with sectors like technology and consumer discretionary often leading gains. Barring any major shocks to economic expectations, equity markets are likely to grind higher in the months ahead.

While volatility is an inevitable part of investing, it remains the price of admission for long-term growth. Looking ahead, investors who maintain a diversified portfolio and stay focused on the underlying economic context are well positioned to benefit from the opportunities that arise as policy settings become more accommodative and growth remains on track.