Inflation and interest rates hit simultaneously, Russell 2000 plunges 11% from August high, marking its first technical correction since March

According to Zhituo Finance APP, the Russell 2000 Index entered a correction zone following Wednesday's steep decline, as rising inflation and interest rates are pushing the market's riskiest stocks below key moving averages.

This small-cap indicator has now fallen more than 10% from its recent peak. After dropping 1.9% on Wednesday, it recorded its first technical correction since March. Wednesday's decline was broad-based, with the number of falling stocks in the index about five times the number of rising stocks. Overall, the indicator is now down 11% from its August high.

The inflation report released on Wednesday showed that prices in September rose at the fastest pace since April, with core inflation exceeding expectations.

Stefano Pascale, Head of US Equity Derivatives Research at Barclays, said, “Small-caps are highly sensitive to interest rates, and with today’s data increasing the risk of policy rates moving higher, that's a bad signal for small-caps.”

Small-cap index is down 11% from its peak

For most of this year, the Russell 2000 Index outperformed the S&P 500 Index, as small-caps are strongly correlated with economic growth, which has been driven by robust consumer spending and large-scale corporate investment in artificial intelligence (AI) infrastructure.

However, after the Federal Reserve raised rates and yields on bonds and Treasury securities soared, the index lost its leading position last month. Small-caps are typically more sensitive to interest rates than large-caps.

In fact, as rates increased, the index has fallen below multiple support levels and, this week, breached the 200-day moving average for the first time since March. Previously, in September and August, it had already fallen below the 100-day and 50-day moving averages, respectively.

Since forming a bearish V-shaped reversal in August, the index has been in a downward trend. This week, it fell below the 23.6% Fibonacci retracement level—about 2,754 points—which had previously acted as support.

Dennis DeBusschere, President and Chief Market Strategist at 22V Research LLC, said Wednesday's CPI increase adds to the risks of further tightening of financial conditions, which will “pose ongoing, more persistent headwinds for small-caps,” affecting consumer and transportation stocks in the same way.

Earlier this year, following a major index rebalancing, high-quality components within this small-cap indicator also saw significant pullbacks. As of June 29, Bloom Energy Corp. (BE.US), Credo Technology Group Holding (CRDO.US), Sterling Infrastructure Inc. (STRL.US), and TTM Technologies Inc. (TTMI.US) together contributed two-thirds of the Russell 2000 Index's gains, and on that very day, all four companies were moved to the Russell 1000 Index.