Key Highlights

● The Russell 2000 rose 1.01% Thursday, its fourth straight gain and eighth in nine sessions.

● The Fed held at 3.75% to 4.00% in a 10–2 vote with two hawkish dissents.

● Futures imply about 85% odds of a December rate increase.

● Third-quarter GDP grew at an annualized 3.4% and core PCE Inflation was 3.1%.

Rising rates are supposed to hurt small companies most. They often rely on floating-rate Debt and have less pricing power than megacaps. Yet the Russell 2000 is outperforming at a time when the Federal Reserve is debating whether to raise rates again.

Around 8 a.m. ET on Friday, Russell 2000 futures were down 0.58% at 2,850.70, according to market quotes. That compared with a 2.62% loss for Nasdaq-100 futures and 1.13% for the S&P 500. On Thursday, the Russell 2000 rose 1.01% to 2,859.22, its fourth straight gain and eighth advance in nine sessions, while the Nasdaq Composite fell 1.38%. Based on closing levels, the index was up 2.23% for October through Thursday, while the Nasdaq Composite was down 2.52%.

A hawkish split

The Fed held its target range at 3.75% to 4.00% on Wednesday, after raising rates in September for the first time in about three years. The vote was 10–2. Governor Lisa Cook and Cleveland Fed President Beth Hammack dissented in favor of a quarter-point increase. The statement upgraded the description of growth to "strong" from "solid." It said the pause allows for "the accumulation of more information."

Chair Kevin Warsh made no commitment on December. He said "monetary medicine is starting to work some," and that inflation remains above target. Futures showed about 85% odds of a December hike, according to media reports. Thursday's data backed the hawks: third-quarter GDP grew at an annualized 3.4%, ahead of the 3.2% consensus. Core PCE inflation was 3.1% year over year, and initial jobless claims were just 194,000.

So why are small caps holding up? The rate market offers part of the answer. The 2-year Treasury yield, which is most sensitive to Fed policy, was near 4.60%, down about 21 basis points over the month, according to market data. Investors appear to be betting that one more hike would be the last, and that it may already be priced in.

Rotation and the counterpoint

The other driver is rotation away from megacap AI stocks. Alphabet (NASDAQ:GOOGL)'s 12.6% drop on Thursday, and premarket declines of about 25% for Intel (NASDAQ:INTC) and about 7% for Amazon (NASDAQ:AMZN), have pushed investors toward cheaper, more domestically focused companies. One market commentary estimated that the "S&P 500 ex-AI" was beating the S&P 500 by about 6.4 points in October. That's a private measure, not an official index. Strong U.S. growth also favors smaller companies that depend on domestic demand.

The risk is that this logic breaks if the Fed delivers more than one hike. Small caps' heavier reliance on floating-rate borrowing means a higher-for-longer policy rate directly raises interest costs. Oil above $100 a barrel adds to input costs and inflation pressure. Today's slide in Russell futures shows that small caps still fall when the overall market sells off. They're just falling less.

Prediction markets heavily favor Democrats winning the House in Tuesday's midterms. That could change the policy outlook for domestic sectors, though its effect on small caps is uncertain.

What to watch

Today's Employment Cost Index (8:30 a.m. ET, consensus 0.8%) is the first test. A hot wage print would raise the odds of a December hike. St. Louis Fed President Alberto Musalem speaks at 12:30 p.m. with Q&A, which could give a read on how other policymakers view the dissents. Next Friday's jobs report is the bigger event for the rate-sensitive Russell 2000. A cooler report would support the idea that the Fed is close to done.