2026 Fed Rate Cut Expectations: Impact on Treasuries and Small-Cap Markets

The report is anchored in a January 1, 2026, Seeking Alpha article discussing market expectations for early 2026 Fed policy [1]. By late December 2025, Treasury and Fed funds futures priced in additional rate cuts beyond the Fed’s median projection of one quarter-point cut in 2026—market expectations implied two more cuts [3][4]. This disconnect drove a 4-basis-point weekly decline in 10-year Treasury yields (as of December 19, 2025), signaling investor confidence in gradually loosening financial conditions [2].

The Russell 2000 (^RUT), a small-cap proxy, showed moderate volatility in late 2025: a 1.92% decline between December 15–31, 2025, followed by a slight 0.22% 1-month gain as of January 1, 2026 [0]. This mixed performance reflects small-caps’ sensitivity to interest rates and credit conditions (due to higher short-term borrowing reliance), with investors weighing rate-cut benefits against near-term economic headwinds [0].

1. Small-Cap Vulnerability
   : Small-cap stocks’ volatility underscores their sensitivity to rate changes and credit access, making their fundamentals highly dependent on actual policy easing and credit market conditions [1].
2. Market-Fed Disconnect
   : The gap between market rate-cut expectations and Fed projections creates potential for volatility, particularly around the January 28, 2026, FOMC meeting, where policy updates could align or contradict market pricing [4].
3. Catalyst Dependence
   : Upcoming economic data (inflation, nonfarm payrolls) will be critical in shaping both Fed decisions and investor sentiment, with implications for Treasury yields and small-cap performance [2].

• Misaligned Expectations
  : A Fed failure to cut rates as aggressively as markets project could trigger sell-offs in small-caps (priced for looser conditions) and long-dated Treasuries [5].
• Inflation Resurgence
  : Rebounding inflation may force the Fed to reverse rate cuts, tightening conditions and harming small-cap borrowers [5].
• Credit Stress
  : Persistent credit market tightening (unconfirmed by late 2025 data) could limit small-caps’ capital access, undermining looser condition assumptions [1].

• Potential rate cuts may ease small-caps’ borrowing costs, benefiting those with manageable debt levels and strong credit access [1].
• Clarity from the FOMC and positive economic data could reduce volatility and support small-cap performance [2][4].

• Market expectations (late 2025) priced 3 quarter-point Fed rate cuts in 2026, vs. the Fed’s projected 1 [3][4].
• 10-year Treasury yields eased 4 basis points in late December 2025 amid rate-cut expectations [2].
• The Russell 2000 showed late-2025 volatility, reflecting small-caps’ sensitivity to macroeconomic and policy factors [0].
• Critical catalysts include the January 28, 2026, FOMC meeting, upcoming inflation/payroll data, and credit conditions reports [2][4].