Risk-Off Mood Drags Down Market Leaders as Hopes for Fed Cuts Fade

Federal Reserve officials are navigating without their usual visibility after the prolonged US government shutdown cut them off from key economic data, leaving policymakers and investors on edge.

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That uncertainty spilled into the markets on Thursday, sparking a wave of risk aversion that dragged down some of the year’s strongest-performing stocks and deepened the recent selloff in cryptocurrencies. Many traders pointed to fading expectations for a December interest-rate cut as the main catalyst. Swaps markets now show only about a 50% chance of a cut, sharply lower than the 72% odds priced in just a week earlier, as recent Fed commentary has offered no clear signal that another move is imminent.

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Stocks tied to momentum strategies including those heavily favored by retail traders absorbed the brunt of the selloff, posting their steepest drop since April after leading the market for much of the year.

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Momentum investing typically involves buying stocks that have recently surged while shorting underperformers. Many of the big winners in this strategy have been artificial intelligence–themed names that soared amid broad enthusiasm around the technology.

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“The expectation of lower interest rates was a major reason investors were willing to overlook the elevated valuations on momentum stocks,” said Matt Maley, chief market strategist at Miller Tabak + Co. “Now that those expectations are fading, investors are trimming exposure to the priciest areas of the market.”

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Bank of America Corp.’s index of high-momentum stocks tumbled 4.7% on Thursday, marking its sharpest decline since April, when tariff concerns under President Donald Trump rattled markets. Even after the drop, the basket had climbed as much as 63% from its April lows.

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These momentum names are largely growth stocks, which tend to be more sensitive to interest rates because lower borrowing costs reduce the discount rates used in valuation models.

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That dynamic helps boost their price-to-earnings multiples, explained Michael O’Rourke, chief market strategist at Jonestrading. “If rates aren’t coming down as quickly as investors expected, those valuation models need to adjust,” he said. “That recalibration naturally leads to selling.”

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AI beneficiaries had already begun to show signs of fatigue in recent weeks as concerns mounted over stretched valuations and rising capital expenditures. Those pressures intensified Thursday. Among AI-linked names in Bank of America’s momentum basket, Sandisk Corp. slid 14% and Astera Labs Inc. dropped 8.4%. Large-cap AI players were hit as well: Nvidia Corp. slipped 3.6%, Broadcom Inc. lost 4.3% and Palantir Technologies Inc. sank 6.5%.

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Across major US benchmarks, the Nasdaq 100 Index recorded the steepest losses with a 2% decline, while the S&P 500 Index fell 1.7%. Bitcoin extended its slide from an October peak, dropping more than 22%.

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The retreat was even more pronounced among stocks popular with retail traders. Barclays analysts recently highlighted a “significant decline” in retail activity, based on the bank’s equity euphoria index. The Citi US Retail Favorites basket plunged 6% its worst performance since April after nearly doubling in the 12 months through mid-October before giving back 15%.

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A meme-stock ETF dominated by Opendoor Technologies Inc. fell more than 11%, its steepest drop since launching last month. Meanwhile, the VanEck Social Sentiment ETF and Cathie Wood’s ARK Innovation ETF both sank more than 5%. Highly leveraged products tied to Bitcoin miners and quantum-computing stocks fared even worse, with some plunging more than 20%.

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Even the most-shorted names were caught up in the turmoil. A Goldman Sachs index comprising the most heavily shorted US companies with market caps above $1 billion slid 5.5%, also marking its worst day since April.

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Underlying much of the day’s anxiety was a basic question: What will the Fed do next? Policymakers are contending with stubborn inflation and a cooling labor market while lacking the government data they normally rely on. The shutdown the longest on record delayed or canceled essential economic reports just as the Fed was grappling with increasingly divided views on policy.

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Last month, the Fed delivered its second consecutive quarter-point rate cut, yet Chair Jerome Powell cautioned that another move was far from guaranteed. On Thursday, the debate inside the central bank was on full display. St. Louis Fed President Alberto Musalem argued for a careful approach, noting that inflation remains above the Fed’s 2% goal.

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Minneapolis Fed President Neel Kashkari repeated that he did not support the last rate cut and remains undecided about December. Cleveland Fed President Beth Hammack added that policy should stay “somewhat restrictive.”

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“I can make a case for a cut or for holding steady it depends entirely on how the data comes in,” Kashkari said.

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With the government finally reopened, traders now await a backlog of delayed reports that could offer clarity. But even when those numbers arrive, some analysts believe the broader trend is already clear.

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“The accumulation of headline anxiety has created real volatility in equity markets,” said Paul Christopher, head of global investment strategy at Wells Fargo Investment Institute. He urged investors to look toward the potential for lower rates next year. “Even a wave of delayed data is unlikely to overturn the steady evidence of softer job growth that state-level and private-sector figures confirmed during the shutdown.”

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