Russell's Rally Threatened by US GDP

After the Fed announced it was giving up on rate hikes, stocks have been on the rise, but will the US economy be able to keep up with the optimism?

The Santa Rally is Here

Last week, US stocks recorded their best gains in six years in the wake of the FOMC's interest rate decision. The Fed left rates unchanged, but the prospect of rate cuts in the coming year drove optimism higher just as markets were settling in for the extended holidays. Among the indices, the small-cap Russell 2000 was the best performer, picking up 5.5% in the five days of trading. But since the rate decision, some Fed officials have tried to push back on what they see as the market expecting too many cuts next year. The Fed sees only three cuts, while the market has priced in five.

That hasn't so far dented investor enthusiasm, but a couple of risk data points are coming up. Tomorrow is the third and final reading of the US Q3 GDP number, which is expected to be confirmed at the revised 5.2% annual rate. That could provide a positive note, but the momentum will be hard to maintain. The Fed's GDPNow tracker sees US GDP growing at half that rate for the final quarter of the year, at 2.6%. Still, a cooling economy is far from slipping into a recession that many had feared the aggressive rate hiking could provoke. That could give some more room for the Russell 2000 to stretch its legs through the remainder of the year.

Prices Are High, But Coming Down

To set expectations for what might happen after, investors are likely to keenly pay attention to the Fed's preferred inflation gauge, which will be released on Friday. November's annual core PCE rate is expected to be 3.4%, down slightly from the 3.5% reported in October. But the monthly figure is expected to show a more amenable reading for easing, forecast to remain unchanged at 0.2% growth.

Fed Chair Jerome Powell put substantial emphasis on inflation in this post-rate decision presser, stressing that although the rate of price increases is slowing, there is still a long way to go. The PCE figure could remind investors that the Fed isn't fully satisfied with the inflation rate yet, which might dent the Santa Rally. On the other hand, a surprise to the downside could confirm the market's optimism and extend the runway for small caps represented in the Russell 2000. Changes in monetary policy are seen as better for smaller companies, as they are thought to have more flexibility to deal with the changing environment.

Russell 2000 Outside Range Top?

Confirming the recent breakout of the range top at 2035 could signal an extension towards 2425, which is equal to the length of the range. Two big levels can be seen before there, one by the gap fill of 2165 and the other by the swing high of 2280. In case the breakout is a fakeout, a rejection could open the door to 1905, potentially leading to 1840 and even lower.

Source: SpreadEx / RUSSELL 2000

Key Takeaways

US stocks experienced a significant rally after the Fed announced it would not raise rates. The small-cap stocks index saw gains of 5.5% in a week. However, some officials have expressed concerns about the market's future expectations of multiple rate cuts. The upcoming US GDP report for Q3 is expected to show growth of 5.2% annually, but the Fed's GDPNow tracker predicts slower growth of 2.6% for Q4. A cooling economy may affect the rally's sustainability in small-cap stocks. Additionally, investors will monitor the PCE  to gauge the Fed's future actions.