Stock market melt-up is being fueled by blind belief in lots of rate cuts in 2026

Key Points

• Research suggests the stock market melt-up is being fueled by expectations of significant rate cuts in 2026, with the futures market pricing in more cuts than the Federal Reserve's projections.

• The evidence leans toward investor optimism driving the rally, but there is controversy, as the Fed expects only one rate cut in 2026, while the market anticipates around two to three cuts, potentially reflecting differing views on economic slowdown risks.

• It seems likely that this belief, while based on plausible economic factors like geopolitical tensions, could be seen as overly optimistic if economic conditions do not deteriorate as expected.

Market Performance and Melt-Up

The stock market has experienced a significant rally, with the S&P 500 reaching a record high of 6,279.35 as of July 3, 2025, consistent with a melt-up driven by expectations of lower future interest rates. Lower rates typically boost stock prices by reducing borrowing costs and increasing the present value of future earnings.

Expectations for Rate Cuts

The Federal Reserve's June 2025 dot plot projects one 25-basis-point (bps) rate cut in 2026, bringing the federal funds rate to a range of approximately 3.5%-3.75% by year-end, down from the current 4.25%-4.5%. However, the futures market, as reflected in Secured Overnight Financing Rate (SOFR) futures, prices in a 65 bps lower yield for December 2026 compared to December 2025, suggesting market expectations of around two to three cuts (65 bps / 25 bps ≈ 2.6), implying a rate of about 3.25% by December 2026.

Investor Sentiment and Risks

This discrepancy highlights investor optimism, potentially fueled by concerns about economic slowdowns, geopolitical risks like U.S. military actions, and tariff impacts. However, the Fed's cautious stance, possibly due to inflation risks, suggests the market's expectation could be seen as aggressive or "blind" if economic conditions do not worsen as anticipated.

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Survey Note: Detailed Analysis of Stock Market Melt-Up and Rate Cut Expectations

This note provides a comprehensive analysis of the stock market's recent performance and the role of expectations for Federal Reserve rate cuts in 2026, addressing the observation that the market melt-up is being fueled by a belief in significant rate reductions. The analysis is based on recent data, market reports, and economic forecasts as of July 6, 2025, at 11:52 AM PDT, ensuring a thorough understanding of the current financial landscape.

Market Performance Overview

The stock market has experienced a notable rally, often described as a melt-up, characterized by rapid and significant increases in stock prices. As of July 3, 2025, the S&P 500 reached a record high of 6,279.35, reflecting a year-to-date increase and hitting back-to-back highs by the end of June 2025. This performance is consistent with investor optimism and aligns with expectations of lower future interest rates, which typically enhance stock valuations by reducing borrowing costs and increasing the present value of future earnings.

Federal Reserve Projections for Rate Cuts

The Federal Reserve's monetary policy outlook, as detailed in the June 2025 Federal Open Market Committee (FOMC) meeting, provides insight into its expectations for interest rate adjustments. The dot plot, a key tool for gauging Fed officials' projections, indicates the following for future rate cuts:

Year	Expected Rate Cuts (Basis Points)	Federal Funds Rate Target Range by End of Period
2025	50 (two 25 bps cuts)	3.75%-4.0%
2026	25 (one 25 bps cut)	Approximately 3.5%-3.75%
2027	25 (one 25 bps cut)	Not specified in detail, around 3.4% by 2027

These projections reflect a cautious approach, with only one rate cut anticipated in 2026, down from two previously projected in March 2025. This adjustment suggests the Fed is responding to elevated inflation risks, particularly from tariffs and stable unemployment rates, as noted in recent FOMC statements.

Market Expectations for Rate Cuts in 2026

In contrast, the futures market, as reflected in Secured Overnight Financing Rate (SOFR) futures, indicates a more aggressive expectation for rate cuts in 2026. According to a report from The Globe and Mail dated June 24, 2025, traders' SOFR bets have pushed the implied yield of futures contracts maturing in December 2026 to 65 basis points (bps) below those expiring in December 2025, a record low spread. This suggests the market anticipates a significant rate reduction, implying a federal funds rate of approximately 3.25% by December 2026, compared to the Fed's projection of around 3.625% (midpoint of 3.5%-3.75%).

To contextualize, if the market expects the rate at the end of 2025 to be around 3.875% (midpoint of 3.75%-4.0% after two cuts), a 65 bps decrease by December 2026 would bring it to 3.225%, or roughly 3.25%. This implies the market is pricing in approximately 2.6 cuts (65 bps / 25 bps) from December 2025 to December 2026, significantly more than the Fed's one cut.

Supporting Evidence and Context

The discrepancy between the Fed's projections and market expectations is supported by various analyses. Morningstar, in a report dated June 25, 2025, aligns with the futures market through the third quarter of 2026, expecting a federal-funds target range of 3.25%-3.50% by then, which implies two additional cuts from the end of 2025 (3.75%-4.0%) to Q3 2026, bringing it to 3.25%-3.50%. Morningstar further expects 0.75% (three cuts) in 2026 overall, justifying this by anticipating that the Fed will need to cut aggressively to support economic growth, particularly in housing, despite mild inflation increases from tariffs.

Additionally, The Globe and Mail article notes that this market expectation likely reflects a view that the U.S. economy could hit a deeper slowdown than expected, potentially exacerbated by geopolitical risks such as U.S. military strikes on Iran, which could impact oil prices and inflation. Morgan Stanley, as cited in the same article, predicted seven rate cuts for 2026 following such events, highlighting the market's sensitivity to external shocks.

Investor Sentiment and Market Dynamics

The stock market's melt-up, characterized by record highs, appears to be fueled by this optimism for lower rates. Lower interest rates reduce the discount rate applied to future earnings, making stocks more attractive, especially in a context where economic growth is expected to slow. Recent surveys, such as the AAII Investor Sentiment Survey from July 2, 2025, show 45.0% of investors as bullish, compared to 33.1% bearish, indicating a positive outlook that aligns with expectations of rate cuts. This sentiment is further supported by retail investor activity, with record net purchases during market downturns, as reported by VandaTrack Research.

Risks and Controversies

However, there is controversy around whether the market's expectation for multiple rate cuts in 2026 is realistic. The Fed's cautious stance, as evidenced by its reduced projections, suggests concerns about inflation, particularly from tariffs, which could delay or limit rate cuts. Analysts like those at J.P. Morgan and Deloitte highlight the uncertainty, with some scenarios suggesting potential tightening if inflation rises significantly. The market's expectation could be seen as "blind belief" if economic conditions, such as unemployment (projected at 4.5% in 2026) and GDP growth (trimmed to 1.6% in 2026), do not deteriorate as anticipated, or if the Fed prioritizes inflation control over growth stimulation.

Conclusion

Based on the analysis, it is evident that the stock market melt-up is being fueled by the belief in significant rate cuts in 2026, with the futures market pricing in approximately 65 bps of cuts from December 2025 to December 2026, compared to the Fed's projection of 25 bps. This optimism, driven by expectations of economic slowdown and geopolitical risks, is a key factor in the current rally, as lower rates enhance stock valuations. However, the discrepancy between market and Fed expectations highlights a potential controversy, with the market's view possibly seen as overly optimistic or "blind" if economic conditions do not warrant such aggressive easing. This aligns with the current financial landscape as of July 6, 2025, at 11:52 AM PDT.

Supporting URLs:

• The Globe and Mail: U.S. futures price in more rate cuts in 2026 than Fed’s latest

• Morningstar: How Much Will the Fed Cut Interest Rates?

• CNBC: Fed holds key rate steady, still sees two more cuts this yea

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