Citigroup Warns of Fed Hike Risks Rising: Small Caps Could Be Next Sell-off Target

July 27th, The Citigroup strategy team warned that as the Fed's interest rate hike expectations heat up, small-cap stocks may become the "hardest-hit area" in the market correction. With the Fed's new chair Kevin Wash's policy style leaning hawkish, the market is shifting from relying on forward guidance to focusing on economic data.

Currently, the market's expectation of a rate hike by the Fed this week has risen to over 30%. Stuart Kaiser, head of Citigroup's U.S. stock trading strategy, said that even if the rate is held steady this week, the probability of a rate hike in September remains as high as 70%. Citigroup recommends that investors hedge their risks by buying put options on the Russell 2000 Index ETF (IWM).

Citigroup believes that small-cap stocks are more sensitive to interest rates, economic growth, and the credit environment. In the case of the Fed signaling a hawkish stance, the Russell 2000 Index or large-cap tech stocks may face greater pressure.

Meanwhile, Goldman Sachs data shows that hedge funds are increasing their exposure to the healthcare sector, with related funds showing strong performance recently. From August 2025 to April 2026, healthcare-specific hedge funds had an average return of close to 40%, significantly higher than general equity funds. The influx of funds is believed to be driven by AI-driven new drug development, a surge in healthcare industry M&A, and improved FDA approval efficiency.

The market focus this week remains on the Fed's interest rate meeting and large-cap tech company earnings reports. Citigroup points out that the current market has very high expectations for performance, and even if a company's earnings exceed expectations, individual stocks may still experience a decline due to "profit-taking."