US Rally Could Signal Upside for Australian Small Caps if RBA Follows with Rate Cuts

Small-cap stocks in the US surged on Wednesday, defying weakness in some of the market’s largest companies, as investors bet the Federal Reserve will continue cutting interest rates in September.

Lower borrowing costs are seen as a tailwind for smaller companies that are more leveraged to the economy and reliant on affordable capital to grow.

The small-cap focused Russell 2000 index jumped around 2%, outperforming the S&P 500, which added just 0.3% as major technology stocks dragged.

Small-Cap Rotation

Larry Tentarelli, founder of the Blue Chip Trend Report, described the move as a “rate cut rotation” into small caps.

He noted that easier monetary policy tends to disproportionately benefit these companies.

With this latest gain, the Russell 2000 is now up nearly 5% for the week, on track for its best weekly performance since November.

Rate Cut Hopes Surge

Market expectations for a September rate cut have surged.

Futures pricing now implies almost a 100% probability the Fed will lower the federal funds rate from its current 4.35%–4.50% range, up from less than 60% a month ago.

Calls for cuts intensified after weaker-than-expected July jobs data, downward revisions to earlier labour market figures, and a cooler-than-expected inflation reading.

Some market watchers – including Treasury Secretary Scott Bessent – have gone further, suggesting that the Fed should cut rates by at least 1.5 percentage points, potentially starting with a 50-basis point move next month.

Recent Sector Lag

Despite the rally, small caps have lagged the broader market over the past two years.

Since late 2022, the Russell 2000 has gained less than 26%, compared to a 64% rise for the S&P 500.

A sustained rate-cutting cycle could help close that gap.

Australia to Follow?

If the US small-cap rally gathers momentum, it could set the tone for a similar move in Australia—particularly if the RBA continues to cut rates in coming months.

Australian small caps share many of the same dynamics as their US counterparts: higher sensitivity to financing costs, greater leverage to economic growth, and the potential for earnings expansion in a lower interest rate environment.

For Australian investors, this US rally could be an early signal to start identifying quality small-cap opportunities that stand to benefit from a more accommodative domestic monetary policy.