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Wall St. indexes rally nearly 2%

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Small-cap index touches 2025 highs

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Airlines, retail stocks among top gainers

(Updates after Fed Chair's latest comments on rate cut)

By Shashwat Chauhan and Johann M Cherian

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 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 added 2%, while KBW

regional banking index 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 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 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

has advanced more than 15%, hitting a record high this

month. Power companies Constellation Energy ( CEG ) and Vistra ( VST )

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

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 ), Home Depot ( HD )

and Best Buy ( BBY ) 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

added 3.6%, while American Express ( AXP ) 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 ), Nvidia ( NVDA )

, Amazon.com ( AMZN ), Microsoft ( MSFT ), Meta

Platforms ( META ), Tesla and Alphabet - were

higher, led by Tesla's 5.1% climb.