Aug 22 (Reuters) - Rate-sensitive stocks rallied on Friday after U.S. Federal Reserve Chair Jerome Powell hinted that an interest-rate cut could be on the table in September, citing a shifting balance of risks.
Traders now see a 90% chance of a rate cut next month compared with about 75% before Powell's remarks.
After cutting rates by 50 basis points in September 2024 and 25 points in November and December, the central bank has held steady.
However, growing bets of a cut next month helped homebuilders outperform the broader market recently and powered gains in the shares of banks and retailers.
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.
HOMEBUILDERS
The housing market is significantly dependent on mortgage rates, which remain elevated and have strained demand for new homes. Recent data showed even though groundbreaking for new single-family homes picked up in July, total permit issuance - a guide for future activity - fell to a five-year low.
An index tracking homebuilders (.HGX), jumped nearly 4% on Friday. Its rally had cooled late last year after the Fed lowered its forecasts for the number of cuts it could deliver this year and acknowledged that a lot of Trump's policies could prove to be inflationary.
But rising rate-cut expectations have renewed interest in housing stocks in recent months, and the index is on track for its biggest one-month jump since July 2024. However, analysts have warned that multiple interest-rate cuts are needed to fully revive the sector.
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.
Lenders also feel pressure when the U.S. Treasury yield curve flattens or inverts. 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 yield curve has been steepening - meaning the gap between short-term and long-term interest rates is widening - as short-end bond yields fall on growing expectations that the Fed could resume its cutting cycle.
The S&P 500 banks index (.SPXBK), added 2%, while KBW regional banking index (.KRX), advanced 4.1%.
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 small-cap Russell 2000 index (.RUT), jumped 3.8% to its highest level of this year. After hitting a record high in November, the index has since underperformed Wall Street's S&P 500 (.SPX), as the Fed had taken a cautious stance on interest rates.
UTILITIES
Shares of utility providers are often traded as bond proxies, given their steady stream of earnings regardless of the economic situation. The sector has enjoyed gains of late as government bond yields fell on growing expectations of Fed rate cuts.
The yield on U.S. 2-year Treasury note , which reflects investors' near-term rate expectations, extended its fall after Powell's remarks.
Since the last rate cut in December, the utilities sub-index (.SPLRCU), has advanced more than 15%, hitting a record high this month. 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.
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.
During the first quarter, fears that tariffs would fan inflation and hurt consumer spending resulted in the biggest quarterly decline for the S&P 500 consumer discretionary index (.SPLRCD), since March 2022.
Since the end of March this year, however, the index has jumped almost 16% through May as economic data point to resilient retail sales.
Shares of retailers such as Nike (NKE.N), opens new tab, Home Depot (HD.N), and Best Buy (BBY.N), climbed between 3.1% and 4%. The S&P consumer discretionary index rose 1.1%.
Prospects of higher spending also lifted shares of airlines and credit card firms. The S&P 1500 airlines index (.SPCOMAIR), added 3.6%, while American Express (AXP.N), jumped 4%.
GROWTH STOCKS
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.
All the Magnificent Seven stocks - Apple (AAPL.O), opens new tab, Nvidia (NVDA.O), opens new tab, Amazon.com (AMZN.O), opens new tab, Microsoft (MSFT.O), opens new tab, Meta Platforms (META.O), opens new tab, Tesla (TSLA.O), and Alphabet (GOOGL.O), - were higher, led by Tesla's 5.1% climb.
Reporting by Shashwat Chauhan and Johann M Cherian in Bengaluru, additional reporting by Medha Singh; Editing by Saumyadeb Chakrabarty and Arun Koyyur
