The Federal Reserve delivered its third rate cut of 2025 in December, lowering the federal funds rate to 3.5%-3.75%. With SPY trading near record highs above $690 and Goldman Sachs forecasting two additional cuts in 2026, the question emerges: will continued monetary easing push the S&P 500 ETF to new heights?
Current Market Situation
SPY closed at $690.31 on December 27, 2025, just 0.2% below its 52-week high of $691.66. The ETF has gained approximately 17.7% year-to-date, marking its third consecutive year of double-digit returns. The 52-week range spans from $481.80 (April 7, 2025) to the current highs, reflecting the market's resilience despite inflation concerns and policy uncertainty.
Fed Policy Trajectory
The December 2025 FOMC meeting revealed significant divisions within the committee. The rate cut passed with a 9-3 vote, the first split since September 2019. The Fed's "dot plot" projects just one additional cut in 2026, but markets and major institutions see a different path.
| Forecast Source | 2026 Rate Cuts | Terminal Rate |
|---|---|---|
| Fed Median (Dot Plot) | 1 cut | 3.25%-3.5% |
| Goldman Sachs | 2 cuts (Mar/Jun) | 3.0%-3.25% |
| Market Pricing | ~2 cuts | ~3.0%-3.25% |
| Fed Dissenters (7 members) | 0 cuts | Hold at 3.5%-3.75% |
Fed Chair Jerome Powell stated the Fed is "well positioned to wait and see how the economy evolves," signaling a data-dependent approach for 2026.
Historical Rate Cut Performance
Historical data provides context for the potential S&P 500 trajectory:
| Metric | Historical Average |
|---|---|
| 1-Year Return After First Cut | +4.9% |
| Positive Returns Probability | 70% |
| Monthly Return (Rate Cutting Periods) | +1.7% |
| Monthly Return (Rate Rising Periods) | -0.5% |
| 3-Month Post-Cut Performance | Often negative |
| 6-Month Post-Cut Performance | Typically positive |
However, valuation concerns persist. In historical instances where the S&P 500 declined more than 20% after the first Fed cut, the average trailing P/E was 18. The current S&P 500 P/E ratio of approximately 22 suggests elevated valuations that could moderate upside potential.
Key Factors for 2026
Goldman Sachs Research expects the Fed to pause in January before delivering 25 basis point cuts in March and June 2026. Their analysis suggests underlying inflation has fallen to around 2%, with core PCE expected to recede further once tariff pass-through effects end by mid-2026.
The firm forecasts US GDP growth of 2.6% in 2026, substantially above the 2.0% consensus, driven by reduced tariff drag, tax cuts, and easier financial conditions. Global growth is projected at 2.8% versus consensus of 2.5%.
Morgan Stanley has issued their most bullish outlook in years, citing AI efficiency gains, accommodative policy, and returning operating leverage. JPMorgan's bull case sees the S&P 500 potentially reaching 8,000 if the Fed eases more than expected.
Risk Assessment
| Risk Factor | Impact |
|---|---|
| Elevated P/E (22 vs historical 18) | Limits upside potential |
| Fed Divisions (7 members want no cuts) | Policy uncertainty |
| Tariff Pass-Through | Inflation pressure through mid-2026 |
| Labor Market Weakness | Could prompt faster cuts |
| AI Efficiency Impact | Deflationary, supports cuts |
Goldman Sachs notes that risks are tilted toward more cuts rather than fewer, particularly if AI-driven efficiency measures reduce consumer spending and employment.
Technical Analysis
365 trading days of data for SPY (2024-07-16 to 2025-12-26)