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The Fed cut rates this past Wednesday by 25 basis points, as expected. There's little unity among board members about what to do next.

I'll let the pundits handle that discussion. Today, I want to share how this latest cut is bullish for small cap stocks, which we track via the Russell 2000.

Why a Steepening Yield Curve is Bullish for the Russell 2000

The financial world often talks about the "yield curve". But what does it mean, and why does it matter to you?

In simple terms, the yield curve is the difference between interest rates on short-term and long-term Treasury bonds.

A steepening yield curve happens when long-term rates rise faster than short-term rates. It can also occur when short-term rates fall while long-term ones stay steady or increase.

This setup can signal economic growth ahead. It's generally good news for certain parts of the stock market.

The Fed cut this past week, lowering short-term rates. Meanwhile, long-term rates have been drifting higher since October.

This matters especially for the Russell 2000. Financials make up the largest sector in the index, accounting for around 18%.

This heavy exposure to banks and financial firms is key to understanding why a steepening yield curve could push the index higher.

How Banks Profit from a Steep Yield Curve

Banks make money by borrowing funds at low rates and lending them out at higher rates. The difference between these rates is called the net interest margin (NIM).

In a steep yield curve environment, short-term rates are low while long-term rates are higher. This widens the spread, allowing banks to pocket more profit.

For example, a bank might pay 1% on customer deposits but charge 5% on a 30-year mortgage. If the curve steepens, that gap could grow to 2% vs. 6%, boosting earnings.

This environment also encourages banks to lend more. The potential rewards increase, which can fuel broader economic activity.

The Role of Regional Banks in the Russell 2000

Regional banks are smaller lenders focused on local communities. They make up a significant part of the Russell 2000's financial sector.

Unlike giant national banks, regional banks rely more on traditional banking: taking deposits and making loans. Their profits are closely tied to interest rate spreads.

In a steepening yield curve, regional banks see a direct boost. Lower short-term rates reduce their funding costs, while higher long-term rates let them charge more on loans.

Small-cap companies often borrow at short-term rates. Falling short-term rates make it cheaper for them to finance growth, adding another layer of support.

Why This Makes the Russell 2000 Bullish Overall

With financials as the top sector, any tailwind for banks ripples through the Russell 2000.

Historical trends show that when the yield curve steepens, it often leads to outperformance for small-cap stocks. This is especially true in a "bull steepener" where short rates fall faster.

Investors see this as a sign of improving liquidity and economic optimism. This favors riskier small caps over large caps.

A steeper curve means happier banks and stronger financial stocks. 

If you're eyeing small-cap investments, keep an eye on that yield curve.

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