3 Sector ETFs to Play on Renewed Fed Rate Cut Hopes

In April, inflationary pressures showed signs of easing, with the Consumer Price Index (CPI) on a "core" basis rising 3.6% year over year, in line with expectations. This marked a cooling from the 3.8% increase observed in March. Monthly core price increases also aligned with expectations at 0.3%, down from 0.4% in the previous three months.

In April, inflationary pressures showed signs of easing, with the Consumer Price Index on a "core" basis rising 3.6% year over year, in line with expectations. This marked a cooling from the 3.8% increase observed in March. Monthly core price increases also aligned with expectations at 0.3%, down from 0.4% in the previous three months.

Despite the moderation in inflation, analysts suggest that the Federal Reserve is unlikely to rush into cutting interest rates. Bank of America Securities economist Stephen Juneau stated that while the April data is a positive step, it may not be sufficient to prompt significant action from the Fed just yet, as quoted on Yahoo Finance. Fed Chair Jerome Powell emphasized the need for sustained data before making any decisions regarding interest rates.

But then, retail sales in April remained unchanged, contrasting with a 0.6% increase in March and defying the 0.4% rise anticipated by economists, as reported by Bloomberg, quoted on Yahoo Finance. This unexpected stagnation in consumer spending indicates a possible shift in consumer behavior amidst persistent inflation and higher interest rates. This somber economic data might force the Fed to reconsider its tough stance on monetary policy in the near term.

Return of Fed Rate Cut Bets

We would like to note that following the CPI release, market expectations regarding rate cuts shifted slightly, with a modest increase in the probability of a rate cut in September according to the CME FedWatch Tool. Following the release of data, there was 52.7% chance of a 25-bps worth of September rate cut, down from 50.5% chance recorded a day earlier.

As of However, Powell suggested that the process of bringing inflation back down to the 2% target might take longer and could potentially be more challenging than anticipated. The U.S. benchmark treasury yield was 4.36% on May 15, 2024, down from 4.45% recorded a day earlier.

Sector ETFs to Win

Against this backdrop, below we highlight a few sectors and its ETFs that could perform better in the near term.

Technology – Technology Select Sector SPDR Fund XLK

Tech companies, particularly those in growth phases, often rely on external financing to fund research and development, expand operations, and acquire other businesses. With chances of lower borrowing costs taking shape following softer inflation print, these companies can fund 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 flow used to value these companies yield higher present values for future earnings. In a nutshell, the lower the rate, the higher the value of tech companies' future cash flows. The fund added 2.3% on May 15.

Utilities – Utilities Select Sector SPDR Fund XLU

The utilities sector is a rate sensitive sector as it requires huge infrastructure which places a massive debt burden and the resultant interest obligation on its operators. This leaves the sector with no scope of outperformance in a rising rate environment. As a result, a weak inflation print is good news for the utilities space. In any case, utilities stocks have been in great shape currently due to better demand-supply fundamentals. The fund, which added 1.5% on May 15, yields 3.04% annually.

Real Estate – Schwab U.S. REIT ETF SCHH

This is yet another sector that performs well in a low-rate environment. These stocks often rely on borrowing to finance property acquisitions and developments. Low interest rates reduce the cost of this debt, which can enhance profitability and cash flow.

Moreover, since REITs pay higher dividends, lower interest rates can lead to better cash flows and potentially higher and more stable dividend payouts. This is an attractive phenomenon to income-focused investors. The fund, which gained 1.4% on May 15, yields 3.33% annually.

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