Small Caps Surge with Rotational Shift, Trump’s Taiwan Move Shocks

Market Movements and Uncertainties Shape U.S. and Global Markets

Recent market dynamics have showcased a remarkable shift towards U.S. small cap stocks, driven by a combination of interest rate cut anticipation and electoral fervor surrounding Donald Trump. This transition escalated on Tuesday, but broader global markets are apprehensive about Trump's potential policy implementations if he returns to the White House. During the ongoing Republican convention, Trump reaffirmed his stance on tax cuts, tariff hikes, and foreign policy, notably stating that Taiwan should be responsible for its own defense—a comment that led to a 1% drop in Taipei’s benchmark index.

Taiwan Semiconductor Manufacturing Company (TSMC), the country's chipmaking giant, saw a 3% decline, impacting chip stocks globally. Meanwhile, gold prices experienced an uptick. U.S. megacaps are also feeling the pinch, with notable declines expected for Nvidia for the third consecutive day. Contrarily, U.S. small caps are flourishing, with the Russell 2000 index jumping 3.5% on Tuesday, marking its fifth consecutive day of significant gains and achieving its highest level since January 2022. Over the past week, the index has surged by more than 10%, narrowing its gap with the S&P 500 and the Nasdaq 100.

Volatility Returns to Markets

Despite the optimistic performance of small caps, signs of volatility are re-emerging. S&P 500 futures were down nearly 1%, while Nasdaq futures dropped by 1.3% ahead of Wednesday's market open. The VIX volatility index also reached its highest point in over a month. Nonetheless, the economic backdrop remains moderately positive. U.S. disinflation trends persist, with futures entirely pricing in a Fed rate cut by September and predicting 65 basis points of cuts by year-end.

Canada's June inflation report, which was softer than anticipated, reinforced these expectations. Additionally, the June U.S. retail sales exceeded forecasts, and the Atlanta Fed’s 'GDPNow' growth estimate increased to 2.5% this week from 2% the previous week. Upcoming data on U.S. industrial production and housing starts will be pivotal, alongside the expansion of the earnings season beyond major banks.

International Economic Developments

Globally, the economic scenario is also evolving. The UK's headline inflation matched the target at 2%, slightly exceeding the 1.9% forecast, leading to a rise in the sterling as markets scaled back predictions for a Bank of England rate cut next month. Furthermore, Britain’s new Prime Minister, Keir Starmer, is set to unveil his initial legislative package, addressing his electoral promise to rejuvenate the country after a prolonged period of economic stagnation and political instability.

Key Events to Influence U.S. Markets

Several developments could steer U.S. markets later on Wednesday, including:

U.S. June industrial production and housing starts data Corporate earnings from heavyweights such as Johnson & Johnson, Northern Trust, and United Airlines The Federal Reserve’s Beige Book release and speeches from key Fed officials The new UK government presenting its legislative agenda A news conference by Germany’s Finance Minister on the 2025 draft budget The U.S. Treasury's auction of $13 billion in 20-year bonds

As the markets navigate these uncertain times, both geopolitical developments and domestic economic indicators will play crucial roles in shaping investor sentiment and market trajectories.