The Great Rotation Rattles Markets
Fed pause, weak dollar, and small-cap surge redefine market leadership
Key Highlights
Small caps are decisively outperforming large caps, marking a leadership shift not seen since the mid-1990s.
The Federal Reserve is holding steady, but internal dissent and political pressure are rising.
A weakening U.S. dollar is driving safe-haven demand and reshaping global capital flows.
Global central bank policy divergence is narrowing, with Japan emerging as the key wildcard.
A Fed Pause Meets a Market Inflection Point
The Federal Reserve held its policy rate steady at 3.50–3.75 percent this week, reinforcing its view that economic momentum remains intact even as inflation runs modestly above target.¹ Chair Jerome Powell described growth as “solid” and emphasized that policymakers can afford patience, citing easing wage pressures and a still-resilient labor market.¹ With unemployment hovering near 4.4 percent and inflation roughly one percentage point above the Fed’s objective, officials appear comfortable waiting before adjusting policy.¹
The decision nevertheless exposed growing internal disagreement. Two governors dissented in favor of an immediate rate cut, highlighting a widening divide over how restrictive policy should remain as inflation cools.¹ Political pressure has also intensified. President Trump has publicly called for aggressive rate cuts and initiated an unprecedented probe into Powell’s leadership, raising renewed concerns about the Federal Reserve’s independence.¹ Powell pushed back on the rhetoric, warning against allowing political considerations to influence monetary policy decisions.¹
Markets initially welcomed the Fed’s steady stance, with equities testing record levels early in the week. That optimism faded quickly. The S&P 500 finished little changed, while Treasury yields edged higher, leaving the yield curve inverted but less extreme than in 2025.² Futures markets continue to price in a first rate cut by midyear, signaling confidence that easing is coming even if the timing remains uncertain.²
Small Caps Take the Baton as Leadership Broadens
While headline indexes stalled, market internals told a very different story. Small-cap stocks surged, with the Russell 2000 up roughly seven percent year to date, sharply outperforming the S&P 500.² This marked the fourteenth consecutive session of small-cap outperformance versus large caps, a streak not seen since 1996.³
The move reflects a broader rotation that has been building beneath the surface. After years of mega-cap dominance, investors are reallocating toward value-oriented and cyclically sensitive segments of the market. Mid-cap stocks are also gaining attention as a perceived balance between stability and upside potential.⁴
