US sectors to watch as Fed lines up first rate cut of 2025

By Shashwat Chauhan and Johann M Cherian

Sept 17 (Reuters) - U.S. corporate sectors that are sensitive to interest rates will be in focus as the Federal Reserve looks poised to lower borrowing costs for the first time this year, with most having already notched up gains after Chair Jerome Powell hinted at cuts last month.

After easing rates by 50 basis points in September 2024 and 25 bps each in November and December, the central bank has held borrowing costs steady at 4.25%-4.50%.

Traders have almost fully priced in a 25 bps rate cut as of Wednesday and expect two more such cuts by the end of 2025, according to data compiled by LSEG.

U.S. stock markets are trading at record highs, with technology and bank stocks among the top performers this year, as signs of weakness in the U.S. labor market and tame inflation data fuel bets of monetary easing.

Here is a closer look at how some of the rate-sensitive stocks have fared since the Fed kicked off its rate-cutting cycle last year.

SMALL CAPS

Small-cap companies are largely reliant on external borrowing to fund their operations, and lower borrowing costs increase their available capital.

Lower rates could also enable smaller companies to refinance their existing debt more cheaply, enabling them to then direct a chunk of their earnings to fuel growth and expansion.

The Russell 2000 small cap index .RUT has rallied more than 5% since Powell's comments at Jackson Hole on August 22, though it remains well off its record high close seen back in November 2021.

BANKS

The picture is more complicated for banks.

Lenders usually make more money when interest rates rise because they can charge borrowers more for loans. But if competition for deposits heats up, banks may need to raise the interest they pay to savers, which pushes up their funding costs and eats into profits.

Since banks borrow at short-term rates and lend at long-term rates, a smaller gap between the two reduces their profit per loan. A steep yield curve has the opposite effect, widening margins.

The spread between the yield on two-year and 10-year Treasury notes hit its steepest since April earlier this month but has reversed some of the moves in recent weeks following soft labor market data.

The KBW regional banking index .KRX has gained about 1.4% since Powell's dovish turn, while the S&P 500 banks index .SPXBK has added nearly 5%.

During the second year of monetary policy easing cycles since 1990, U.S. financial stocks rose an average of more than 20%, according to data from CFRA.

GROWTH STOCKS

Growth stocks are companies that are expected to grow at an above-average rate compared to other companies in the market. Interest-rate cuts boost growth and technology stocks, whose valuations rely on future earnings as lower rates increase the present value of those expected profits.

The S&P 500 Growth Index .IGX, which houses Wall Street's biggest tech names including Nvidia NVDA.O, Microsoft MSFT.O and Apple AAPL.O, has climbed more than 17% so far this year.

To be sure, a big part of the jump is because of the boom in AI that has lifted stocks across the tech sector.

Information Technology stocks have on average rallied more than 22% in the year following a Fed cut and pause cycle, according to data from Trivariate Research, averaging nine such instances since 1986.

UTILITIES

Shares of utility providers are often traded as bond proxies, given their steady stream of earnings regardless of the economic situation. Lately, the sector has enjoyed gains as government bonds rallied and yields fell on growing expectations of Fed rate cuts.

The yield on U.S. 2-year Treasury note US2YT=RR, which reflects investors' near-term rate expectations, extended its fall after Powell's remarks at Jackson Hole.

Since the Fed delivered its first interest rate cut in September 2024, the utilities sector .SPLRCU has advanced about 10% and is close to a record high.

Power companies Constellation Energy CEG.O and Vistra VST.N have led gains on hopes they could see a surge in demand from energy-intensive data centers needed to develop AI technology.

However, data from Trivariate Research showed that utilities stocks only logged modest gains and underperformed the benchmark S&P 500 one year after the Fed resumed easing monetary policy after a brief pause as investors sought riskier bets.

HOMEBUILDERS AND HOUSING STOCKS

The housing market is significantly dependent on mortgage rates, which have remained elevated and strained demand for new homes. Recent data showed that sales of new U.S. single-family homes fell in July.

Mortgage rates have eased on expectations that lower borrowing costs could revive the housing market, but continue to outpace wage growth, making home ownership still expensive for many.

An index tracking homebuilders .HGX is on track for its first quarterly gains in a year. However, since the Fed's first interest rate cut in September 2024, it has declined about 3% and analysts say that multiple rate cuts are needed to fully revive the sector.

Data from Trivariate Research showed that real estate overall .SPLRCR underperformed the S&P 500 even one year after the Fed resumed easing monetary policy after a brief pause.

CONSUMER STOCKS

Lower borrowing costs typically boost consumer spending, which makes up about 70% of the U.S. economy. That's good news for retailers.

The Fed's 100 basis points of rate cuts last year propped up individual spending and also helped the S&P 500 consumer discretionary sector .SPLRCD jump about 26% since then.

Fears that U.S. tariffs would fan inflation and hurt consumer spending had stalled that momentum briefly when the sector logged its biggest quarterly decline since March 2022 between January and March this year.

But data, including the most recent Personal Consumption Expenditures Price data, points to the fact that the American consumer is still spending.

Shares of retailers such as Walmart WMT.N and Home Depot HD.N have climbed 15% and 9% this year, respectively.

Prospects of higher spending have also lifted shares of airlines and credit card firms. The S&P 1500 airlines index .SPCOMAIR has added about 1.5% after Powell's comments, while American Express AXP.N has jumped around 5%.

Consumer discretionary stocks have been among the top sectoral performers on the S&P 500 one year after the Fed resumed easing monetary policy after a brief pause, data from Trivariate Research showed.