Rate cuts are coming, and that’s good news for the S&P 500. The question is: How big, and how good?
The latest jobs data is bad enough to force the Fed off its seat and reduce interest rates for the first time since late 2024, when it cut its Fed Funds Rate by one percentage point.
The labor market’s weaknesses are widespread, reflecting increased unemployment, layoffs, and less hiring.
Since encouraging low unemployment is one of the Federal Reserve’s mandates, most Wall Street analysts are convinced that Federal Reserve Chairman Jerome Powell will shift gears and target jobs instead of inflation at its next meeting on Sept. 17, including Goldman Sachs.
Goldman Sachs is considered one of Wall Street’s gold standard companies for research and analysis, with roots tracing back to 1869.
On Sept. 6, its analysts revisited their S&P 500 targets for the rest of 2025 and 2026 based on their rate cut expectations.
The S&P 500 performs best when interest rates are heading lower. The Fed doesn’t control bank lending rates, but it does indirectly influence them because it sets the Fed Funds Rate, the interest banks charge one another on overnight loans of reserves.
Goldman Sachs updated its S&P 500 targets for 2025 and 2026 following the August unemployment report.Image source: TheStreet
The higher the rate, the more banks charge for consumer and business loans. As rates fall, bank loan rates usually follow, providing more wiggle room for households and businesses to spend, propping up corporate revenue, profits, and stock prices.
According to Bank of America, the S&P 500 gains 1.7% per month on average during “rate-cutting regimes.” When rates are rising, it loses 0.5% monthly.
The Fed has resisted lowering rates this year, fearing that doing so would fan inflationary fires even as the full impact of tariffs flows through to consumer prices.
There’s evidence that the Fed isn’t wrong to be nervous since Consumer Price Index (CPI) inflation has risen since April:
July: 2.7%
June: 2.7%
May: 2.4%
April: 2.3%
Nevertheless, Goldman Sachs thinks the shift in the jobs data this summer will trump that fear, clearing the way for Chairman Powell and company to embrace dovish rate cuts soon.
The U.S. unemployment rate has been stuck between 4% and 4.2% for one year; however, the August jobs data showed unemployment rose to 4.3%—a new cycle high and the highest level since October 2021, when it was 4.5%.
“As the economy moves through the worst of the tariff impacts we expect imminent Fed rate cuts,” wrote Goldman Sachs analysts in a client note shared with TheStreet.
The analysts don’t expect a big front-loaded cut of a half-point this month, but they do see a steady pace of cuts throughout the year’s end and into 2026.
“Our economists forecast the Fed will cut the funds rate three times this year… followed by an additional two quarterly cuts in 2026,” said Goldman Sachs.
The S&P 500 has taken a beeline higher since early April, when President Trump reversed course, pausing reciprocal tariffs and clearing the way for trade deals.
After tumbling 19% from its February high through April 8, the S&P 500 has rocketed 30% on optimism that negotiations would lessen tariffs’ bite, and approval of the One Big Beautiful Bill Act tax cuts would offset any economic hit.
The gains have increased the benchmark index to all-time highs, closing on Friday at 6,481.50.
Goldman Sachs believes Fed rate cuts will provide enough catalyst to support additional gains through year’s end; however, returns will be more muted than we’ve witnessed since springtime.
“The US economy will avoid a recession. During the last 40 years, the S&P 500 has typically generated positive returns following the resumption of Fed cutting cycles during which the economy continued to grow,” wrote Goldman Sachs.
Overall, the analysts expect that the S&P 500 could rise an additional 2% through the end of 2025, and 6% through mid-2026.
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“Our return forecasts correspond to price levels of 6600 at year-end and 6900 by mid-2026,” wrote Goldman Sachs.
Goldman Sachs’ forecast for S&P 500 gains next year is rooted in its assumptions that earnings will remain a tailwind.
According to FactSet, Wall Street estimates S&P 500 companies will experience 10.6% earnings growth this year and 13.6% growth in 2026.
“Underpinning our return forecast is our expectation for 7% earnings growth in 2026…S&P 500 EPS will grow by +7% in both 2025 and 2026.,” said the analysts.
Goldman Sachs’ forward earnings estimate for the S&P 500 is more measured than Wall Street consensus, with the analysts writing, “downward revisions to consensus earnings forecasts leads us to expect analysts will ultimately revise their estimates closer to ours.”
Regardless, earnings growth is the lifeblood of stock market returns, and even below-consensus growth leads them to think the path of least resistance through mid-2026 will ultimately be higher.
“There is still room for ‘catch-up’ trades to continue in pockets of the market that have lagged, wrote Goldman Sachs. “While the S&P 500 index sits slightly below its high, the median constituent remains 11% below its 52-week high.”
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