A Fed Cut Looks Imminent—And Bond ETFs Could Be The Biggest Trade

Bondholders aren’t waiting for the FOMC announcement on Wednesday. They’re already pouring into Treasuries in anticipation of the Federal Reserve’s widely anticipated September 25-basis-point rate cut. With the nine-month hiatus behind them, Wall Street is convinced the Fed is poised at last to ease, and the trade of the moment reduces to one word: duration. For ETF investors, that means opportunity.

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When interest rates decline, longer-dated bonds increase more quickly in value than shorter maturities. In the recent months, the yield curve has been steepening as rising anticipation of rate cuts lead to a dip in the short end, while sticky inflation keeps the long end elevated.

That’s why vehicles such as the iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) and the iShares 7–10 Year Treasury Bond ETF (NASDAQ:IEF) can become the go-to ammunition for those wagering on a Fed pivot. TLT, in particular, offers high sensitivity to rate action, making it the purest means to capitalize on the duration trade.

As per Reuters’ citing of Morgan Stanley’s Vishal Khanduja, taking on five- to ten-year bonds has been the sweet spot: “If the Fed shifts from restrictive to dovish, and (policy) rates, for example, go down from 4.25% to 3.25% in the next three meetings, then you could clearly say that your overall interest rate curve should also be going lower……That means the higher the duration you have in the fixed income portfolio, you should be mathematically making positive returns because your duration is directly sensitive to the yield.” That math is what ETF investors are seeking.

The urgency is clear. Reuters reports J.P. Morgan clients have boosted their outright long-duration bets to the highest level since early August, while government money-market funds have quietly extended their weighted average maturities to the longest since mid-2021. Options activity in SOFR futures which is tied closely to Fed rate expectations, has surged to record levels, signaling traders are all-in on rate cuts.

The backdrop is a labor market that’s cracking up, with unemployment rising to 4.3% in August and jobs growth softer than anticipated. That movement has prompted the Fed to take potential action after remaining on hold on rates for months, despite inflation still being slightly too high for policymakers’ liking. Traders interpret this as the first act of an eventual easing cycle that might go on into 2026.

The bottom line is if the Fed is indeed pivoting, bond ETFs may be the simplest, quickest means for investors to front-run the move. The only question remaining is do you want a safer perch on the short end, or a front-row ride on long-duration rockets like TLT?

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Image created using artificial intelligence via Midjourney.