The Fed Is in No Rush to Cut Rates. Markets Are Getting a Head Start.

The Federal Reserve has kept interest rates unchanged this year. (Chip Somodevilla/Getty Images)

The Federal Reserve is holding off on cutting interest rates, but financial conditions have loosened up on their own—essentially suggesting the market is doing the Federal Reserve’s job for it.

Investors might not know it, but their exuberance is effectively buying the Fed more time to keep monetary policy steady.

Evidence of market optimism is all around us. We’ve come full circle: The stock market has recovered from its April lows and has now surpassed highs last seen in February, back when strategists were upping their S&P 500 targets on hopes for lower taxes and deregulation heralded by the Trump administration.

The turnaround since April is visible across almost all assets, suggesting the market has shrugged off fears of a full-on war between Israel and Iran and concerns about President Donald Trump’s tariffs. Bitcoin, a high-risk, high-return asset, rebounded from its April lows, while artificial-intelligence stocks are getting a fresh boost. Nvidia and Super Micro Computer, have each gained more than 50% from their April slumps. Meanwhile, the nation’s riskiest companies are paying investors less money to take on their debt—corporate junk bonds, on average, are yielding 6.8%, the lowest level seen this year.

The end result is effectively that markets are experiencing the feel-good effects of an interest-rate cut, without the Fed having to enact one.

That optimism is getting captured in the Financial Conditions index by the Federal Reserve Bank of Chicago. Its latest reading from the end of last week, at about negative 0.5, implies the U.S. is in an environment where money is flowing easily through the economy, it’s easier to get loans, and companies’ profit margins are more likely to increase. The lower the index’s level, the looser economic conditions are. In April, it stood at negative 0.4.

Updated weekly, the Chicago Fed’s index looks at 105 market- and survey-based inputs, including yield spreads on government bonds, the U.S. dollar index—and more important—the level of the stock market. Currently, risk, leverage, and credit indicators are all negative, suggesting risk measures, like asset price volatility and funding risk, are low while there’s less financial leverage in the system and lending conditions are easier than average.

Created with Highcharts 9.0.1Loosening UpEven without a Fed rate cut, financial​conditions are easing as the drop since​April shows.Source: Federal Reserve Bank of ChicagoNote: The Chicago Fed’s National Financial​Conditions Index

Created with Highcharts 9.0.1Jan. 2025June-0.525-0.500-0.475-0.450-0.425-0.400-0.375

Policymakers keep an close eye on financial conditions to understand the impact of monetary policy on the economy and markets. Bloomberg’s financial conditions index also reflects this trend toward easier conditions. The index moved to 0.45 on Thursday from as low as negative 1.583 in April. Positive values, in this index, indicate more accommodative financial conditions than the norm.

It’s striking these conditions come despite the Federal Open Market Committee keeping interest rates higher for longer, in a range of 4.25 to 4.5% throughout 2025. Policymakers’ concern is that U.S. businesses, who are paying additional costs to import goods due to tariffs, can potentially pass those on to consumers through price increases, reigniting inflation.

“We really don’t know how much of that’s going to be passed through the consumer. We have to wait and see,” Fed Chair Jerome Powell said in congressional testimony on Tuesday.

Markets could be rushing to new highs in anticipation of a future rate cut; more than 73% expect a quarter-percentage-point cut when the Fed meets on Sept. 16-17. Comments from Fed speakers have made it clear the future path of interest rates is lower.

But there’s a tack-on effect from the markets’ front-running the Fed—when conditions are already accommodative, that weakens the rationale for the central bank to actually lower rates and stimulate the economy

“We think this gives the Fed some flexibility to keep the Fed fund rates at current levels for longer than consensus expects in light of sticky service and tariff-based inflation as well as Trump’s political interference with the Fed,” wrote Wolfe Research Chief Investment Strategist Chris Senyek this week.

One caveat here is the stock market, as we know, isn’t the economy. Rising markets don’t necessarily have the same stimulative effect on the economy as a lower interest rate.

The Fed understandably has concerns about lowering rates now—but the market’s party has started nonetheless.

Write to Karishma Vanjani at karishma.vanjani@dowjones.com.