ASX shares at the smaller end of the market are outperforming along with the Australian dollar as the global investors up their bets that the US Federal Reserve will make its biggest ever interest rate cut in over 10 years.
The S&P/ASX SMALL ORDINARIES (Index:^AXSO) (ASX:XSO) index rallied 0.8% compared to the 0.7% gain in the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) during morning trade.
The Cynata Therapeutics Ltd (ASX: CYP) share price, Telix Pharmaceuticals Ltd (ASX: TLX) share price and Silver Lake Resources Limited. (ASX: SLR) share price are leading the market minnows higher at the time of writing.
Why small caps are outperforming
Small caps are in a sweet spot. Low interest rates lift valuations for the sector more than large caps. The jump in the Aussie also helps small companies more as they tend to sell their wares domestically but pay for supplies in US dollars.
The Aussie jumped 0.9% to US70.73 cents and looks poised to attempt to break above US71 cents in the short-term after comments from two US Federal Reserve board members lifted expectations that the central bank would slash the Fed Fund Rate by 50 basis points, or 0.5 percentage points.
That is a big and rare move. The Fed, as with the Reserve Bank of Australia (RBA), tend to move rates in blocks of 25 basis points. The last time the Fed made a greater than 25-point move was during the darkest moment of the GFC in 2008.
The market was pricing in around a 36% chance of a 50-point cut but this jumped to nearly 70% following comments by Fed members John Williams and Richard Clarida.
Rising odds for a 50 basis point rate cut
John Williams said it pays for the Fed to move quickly when it has so much stimulus at its disposal while Clarida said the Fed might have to act early and not wait "until things get so bad", reported the Australian Financial Review.
Such a large cut is likely to put pressure on other central banks, including ours, to make deeper cuts than what most economists are forecasting.
It could also send alarm bells ringing as 50-point cut is typically used only in emergencies. Strength in equity markets indicate that investors don't think we are facing a crisis and a bigger than normal reaction by the Fed could prompt many to wonder if things are worse than they appear.
We could be in for a "buy the rumour, sell the fact" moment for the share market. Stocks could outperform for the next two weeks ahead of the Fed meeting and suffer a sell-off on the central bank's decision.
Central banks should be calming markets. In this case, we could get the opposite effect.
