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US SMALL CAP RALLY IS NOT PRICING IN A HAWKISH FED RATE CUT

ADMIN || 10th December 2025

Small caps are seeing a much stronger December than their large-cap peers as expectations for more interest rate cuts help solidify an improving earnings outlook in 2026. Their gains, however, are at odds with rising Treasury yields lifted by fears of a hawkish tilt at the Fed.

The Russell 2000 has outpaced the S&P 500 over the past month on anticipation of more Fed easing, which would help reduce the burden of borrowing costs for many of its constituents. This is an index where 40% of members are unprofitable and many are struggling to earn enough to cover their debt costs. Lower interest rates is the key catalyst this group has been eagerly waiting for to unlock the robust earnings recovery that Wall Street anticipates next year.

Their rally stands at odds with a push higher in Treasury yields in recent days predicated on worries that the US will soon follow many of its global peers with a more hawkish pivot as inflation remains uncomfortably high. Expectations of a “hawkish cut” have become so worryingly consensus that it raises the risk of a more dovish surprise should policy makers stress labor-market concerns as private-sector data deteriorated.

Small caps and bonds can’t both be right at the same time: The former hinge on Fed cuts, the latter threaten to erode them with rising yields that reverberate across the economy. Wednesday will hint at which narrative the market chooses to run with.

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