ETFs
3 sector ETFs will play on renewed hopes of Fed rate reduction
In April, inflationary pressures showed signs of easing, with the Consumer Price Index (CPI) on a “core” basis increasing 3.6% year-on-year, in line with expectations. This is a slowdown from the 3.8% increase seen in March. Monthly core price increases are also in line with expectations, at 0.3%, compared to 0.4% in the previous three months.
In April, inflationary pressures showed signs of easing, with the consumer price index on a “core” basis increasing 3.6% year-on-year, in line with expectations. This is a slowdown from the 3.8% increase seen in March. Monthly core price increases are also in line with expectations, at 0.3%, compared to 0.4% in the previous three months.
Despite moderating inflation, analysts suggest the Federal Reserve is unlikely to rush to cut interest rates. Stephen Juneau, an economist at Bank of America Securities, said that while the April data is a positive step, it may not be enough to prompt the Fed to take meaningful action just yet, as cited on Yahoo Finance . Fed Chairman Jerome Powell has emphasized the need for sustainable data before making any interest rate decisions.
But then, retail sales in April remained unchanged, contrasting with a 0.6% rise in March and defying the 0.4% rise anticipated by economists, as reported by Bloomberg, cited on Yahoo Finance. This unexpected stagnation in consumer spending indicates a possible shift in consumer behavior amid persistent inflation and higher interest rates. These gloomy economic data could force the Fed to reconsider its tough monetary policy stance in the near term.
Return of bets on Fed rate cuts
We would like to note that after the CPI release, market expectations for rate cuts have changed slightly, with a slight increase in the likelihood of a rate cut in September according to the CME FedWatch tool. Following the data release, there was a 52.7% probability of a 25 basis point rate cut in September, compared to the 50.5% probability recorded a day earlier.
However, Powell suggested that the process of bringing inflation back to the 2% target could take longer and could be more difficult than expected. The benchmark U.S. Treasury yield was 4.36% on May 15, 2024, down from 4.45% a day earlier.
Sector ETFs to win
In this context, below we highlight a few sectors and their ETFs that could perform better in the short term.
Technology – SPDR Fund for Selected Technology Sector (NYSE:XLK)
Technology companies, especially those in a growth stage, often rely on external financing to fund research and development, expand operations, and acquire other companies. With the possibility of lower borrowing costs following a slowdown in inflation, these companies can finance their innovations with cheaper capital.
Technology stocks are often valued based on future earnings potential rather than current profitability. When interest rates are low, the discounted cash flows used to value these companies generate higher present values for future earnings. In summary, the lower the rate, the higher the value of future cash flows for technology companies. The fund added 2.3% on May 15.
Utilities – Selected Utilities Sector SPDR Fund (NYSE:XLU)
The utilities sector is a rate-sensitive sector because it requires enormous infrastructure that imposes a massive debt burden and resulting interest obligations on its operators. This leaves the sector with no room for outperformance in a rising rate environment. As a result, low inflation is good news for the utility sector. Regardless, utility stocks are currently in very good shape thanks to improving supply and demand fundamentals. The fund, which gained 1.5% on May 15, returns 3.04% per year.
Real Estate – Schwab US REIT ETF (NYSE: SCHH)
This is another sector that performs well in a low interest rate environment. These securities often rely on borrowing to finance real estate acquisitions and developments. Low interest rates reduce the cost of this debt, which can improve profitability and cash flow.
Additionally, because REITs pay higher dividends, lower interest rates can lead to better cash flow and potentially higher and more stable dividend payments. This is an attractive phenomenon for income-oriented investors. The fund, which gained 1.4% on May 15, has an annual return of 3.33%.
To read this article on Zacks.com click here.