The Federal Reserve’s recent decision has had little impact on the overall stock market at first glance. The S&P 500 has dropped slightly, down by 2 points from its earlier level. In contrast, smaller cap stocks are reacting more positively to the Fed’s forecast. The Russell 2000 index, which tracks small cap stocks, has increased by 1.7% today, reaching its highest point since November 2024.

Federal Reserve Updated Forecast

The Fed’s updated forecast now predicts two interest rate cuts this year, up from one expected earlier. This boost in small cap stocks brings the Russell 2000 close to its all-time highs. This shift in the Fed’s outlook highlights the potential for small-cap stocks, which are very sensitive to interest rates. It may be a good time to buy call options on the Russell 2000 index (RUT) or its ETF (IWM) that expire in October and November 2025. Today, call volume surged to nearly three times the 30-day average, showing many traders are already acting on this. The Fed’s softer stance is supported by recent economic data suggesting further rate cuts are likely. The August 2025 Consumer Price Index report revealed core inflation dropped to 2.8%, its lowest since mid-2022. Additionally, recent employment data shows payroll growth slowing to under 100,000, giving the Fed plenty of reasons to ease financial conditions.

Divergence Trade Opportunity

The flat performance of the S&P 500 indicates that a divergence trade is possible. Before today, the Russell 2000 had only risen 4% this year, while the S&P 500 climbed 12%. This Fed decision could help small caps to close that gap. We can act on this by going long on Russell 2000 futures and shorting S&P 500 futures at the same time. We saw a similar situation in late 2023 when the market began anticipating the Fed’s rate cuts for 2024. During that time, small caps, which had lagged all year, experienced a strong rally that outperformed large-cap stocks. History shows these rotations can gain momentum quickly once they start. With more clarity on the Fed’s plans for this year, we can also expect less volatility in the broader market. The VIX index is already reflecting this, dropping below 14 for the first time in months. Selling out-of-the-money put spreads on the IWM is a smart way to capitalize on this anticipated stability and the underlying upward trend. Create your live VT Markets account and start trading now.

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