Russell 2000 on correction path as Iran war fans inflation fears, rate-cut bets dim

March 20 (Reuters) - The Russell 2000 index dropped 10% from its record-high close in January, putting it on track for a correction on Friday, as renewed inflation fears stemming from the Middle East conflict eroded expectations of U.S. rate cuts this year.

The economically sensitive small-cap index dropped 2% to 2,442.75 points on Thursday. It had closed at a record high of 2,718 points on January 22.

If the index closes 10% or more below the peak, it will confirm a technical correction based on a widely used definition. It will be the first of Wall Street's indexes to mark a correction this year.

The U.S. Federal Reserve, among other central banks, struck a hawkish tone this week, projecting higher inflation and a single reduction to borrowing costs in 2026.

Money market participants scaled back bets on Fed rate cuts, now widely expecting a reduction only next year, according to CME Group's FedWatch Tool. Investors had anticipated two cuts before the U.S.-Israeli war on Iran broke out.

The war slammed global financial markets this month, with strikes across Iran and attacks on energy infrastructure in the Gulf disrupting production and shipping through the crucial Strait of Hormuz.

Brent crude futures have spiked more than 50% since the start of the conflict, raising expectations that interest rates will remain higher for longer to combat inflationary pressures.

Economic data earlier in March also showed a sharp deterioration in the U.S. labor market, putting the central bank in a tough spot and clouding the outlook for interest rates.

Small-cap firms are considered vulnerable in a higher interest rate environment as they tend to rely more heavily on borrowing to support growth than their large-cap counterparts.

The Russell 2000 index had rallied to a record high in January after a strong start to 2026, buoyed by investors looking beyond lofty technology valuations.

"We viewed the rally with a huge degree of skepticism and now that they're falling, it makes a lot more sense to us because they're hit by growth concerns, credit concerns and by concerns around the Fed not easing this year," said Sameer Samana, head of global equities and real assets at Wells Fargo Investment Institute.

The Russell 2000 index had confirmed a correction on January 10, 2025, as a resilient economy had prompted traders to pull back on rate-cut bets. (Reporting by Purvi Agarwal in Bengaluru; Editing by Shinjini Ganguli and Shailesh Kuber)