A look at the day ahead in U.S. and global markets from Mike Dolan

The dramatic switch to U.S. small cap stocks over the past week went into overdrive on Tuesday as interest rate cut and election fever combine, but world markets more broadly are getting nervy of the prospect of Donald Trump's return to the White House.

In a series of interviews around this week's Republican convention, Trump set out several of his policy priorities around tax cuts, tariff rises and foreign policy.

The most jarring comment overnight was his assertion that Taiwan should pay for its own defence - which knocked Taipei's benchmark index down about 1% - but it's just one of series of policy directions that's starting to feed market pricing.

Taiwan's chipmaking giant TSMC plunged 3%, the wider Taipei benchmark was down about 1% and chip stocks elsewhere were knocked back. Gold prices rose.

Caught in the slipstream of this chipmaker hit and the week's Wall St rotation, global megacaps such as Nvidia ( NVDA ) are set to fall for the third day.

It's a different picture for small caps however.

The Russell 2000 of soared 3.5% on Tuesday - its fifth straight day of gains greater than 1%, its longest winning streak since April 2000 and highest level since January 2022.

Jumping more than 10% over the past week, the index of mostly domestic-facing smaller business is now up almost 12% for the year to date - narrowing the gap with the S&P500's 19% for 2024 so far and the 21% rise in the Nasdaq 100.

Adjusting for the outsized weightings of the megacaps, the equal-weighted S&P500 is now up almost 9% for the year.

And futures suggest the Russell will hold those gains later.

The gist of the argument behind the shift to better valued small caps from the pricy tech bellwethers is both stepped up interest rate cut speculation but also the tax, tariff and reshoring lean of a possible Trump return - now that his lead in betting markets for a November win has surged to more than 70%.

That home bias has been absorbed pretty well across the board by the big stock indexes so far, with the S&P500 also up marginally to new highs on Tuesday.

VOLATILITY CREEPING BACK

But there are growing signs of volatility and disruption creeping back in - with S&P500 futures down almost 1% ahead of the Wednesday's bell and Nasdaq futures off 1.3%.

The VIX volatility gauge was at its highest in more than a month.

The economic backdrop to the stock market churn seems less worrying.

Resuming U.S. disinflation still has futures fully pricing a first Fed rate cut in September and 65 basis points of rate cuts by year-end. Canada's surprisingly soft June inflation update reinforced that view.

The June U.S. retail sales readout was better than expected and the Atlanta Fed's 'GDPNow' real time growth monitor nudged up to 2.5% this week from 2% last week.

U.S. industrial production numbers and housing starts top the diary later and the earnings season starts to broaden out beyond the big banks.

Overseas, UK headline inflation came in on target at 2% - though that was slightly above the 1.9% forecast and services inflation also picked up steam.

Sterling rose as money markets dialed back the chances of a Bank of England rate cut next month to as little as a one-in-four chance.

Britain's new Prime Minister Keir Starmer will set out his first package of proposed laws on Wednesday, fleshing out how he will honour his election-winning pledge to rebuild the country after years of weak economic growth and political turmoil.

Key developments that should provide more direction to U.S. markets later on Wednesday:

* U.S. June industrial production, June housing starts

* US corporate earnings: Johnson & Johnson, Northern Trust, US Bancorp, Citizens Financial, Discover Financial, Synchrony Financial, United Airlines, Steel Dynamics, Prologis, Kinder Morgan, Crown Castle, Equifax, Elevance Health

* Federal Reserve releases Beige Book of economic conditions; Fed Board Governor Christopher Waller, Richmond Fed President Thomas Barkin and Kansas City Fed chief Jeffrey Schmid all speak

* New UK government sets out its legislative plans for the coming parliament in so-called King's Speech

* German Finance Minister Christian Lindner holds news conference on 2025 draft budget

* US Treasury auctions $13 billion of 20-year bonds

(Editing by Bernadette Baum)