Fed Cuts Rates by 50 Basis Points: Sector ETFs to Play

On Sept. 18, 2024, the Federal Reserve implemented its first interest rate cut in four years, reducing the benchmark rate by half a percentage point (50 basis points). This move comes in response to cooling inflation and a slowdown in the labor market. The Federal Open Market Committee reduced the key overnight borrowing rate to a range of 4.75%–5%.

Impact on Economy

The new rate will impact various consumer financial products such as mortgages, auto loans, and credit cards. While economic indicators such as gross domestic product (GDP) and consumer spending remain strong, the Fed's decision indicates concerns about the labor market and inflation.

The central bank’s preferred inflation measure shows that it is running at 2.5%, still above the 2% target but well below previous the peaks. The FOMC vote was 11-1. Despite the recent move to ease, the unemployment rate remains low at 4.2%, though job gains have slowed (read: ETF Strategies to Follow Amid Likely Fed Rate Cut).

Ongoing Quantitative Tightening

Despite the rate cut, the Fed will continue its quantitative tightening (QT) program, which is slowly reducing its bond holdings. The Fed’s balance sheet now stands at $7.2 trillion, down by $1.7 trillion from its peak, with a current limit of $50 billion in maturing securities being rolled off each month.

Further Rate Cuts Expected by Year-End

The FOMC’s “dot plot” of individual officials’ projections indicates the possibility of another 50 basis points of cuts by the end of the year, aligning with market expectations. The committee also forecasts an additional percentage point of cuts by 2025 and another half-point cut by 2026, eventually reducing the benchmark rate by 2 percentage points.

Market Reaction & Investor Sentiment

The stock market reacted with volatility to the rate cut. Analysts like Tom Porcelli of PGIM Fixed Income warned that the 50 basis point cut is not necessarily the start of a larger series of cuts, as quoted on CNBC. Plus, such a larger cut indicates an economic slowdown.

Sector ETFs in Focus

Investors can seek refuge in safe sectors like consumer staples, healthcare, real estate and utilities if they are potential economic slowdown.

Consumer Staples ETFs

Consumer staples ETFs are exchange-traded funds (ETFs) that focus on companies producing essential goods that consumers buy regularly, regardless of economic conditions. These typically include items like food, beverages, household goods, and personal care products. This sector and its related ETFs are non-cyclical in nature. Consumer staplesETFs like US Consumer Goods iShares ETF IYK, Nasdaq Food & Beverage ETF FTXG and Consumer Staples ETF Vanguard VDC have been staying high lately.

Healthcare ETFs

Healthcare ETFs are often considered a safe investment. Healthcare is a defensive sector, meaning it's less sensitive to economic cycles compared to other sectors. People need healthcare services regardless of the economic climate, which can lead to more stable performance. US Healthcare Providers iShares ETF IHF should also be tracked for gains.

Real Estate ETFs

The sector provides broad exposure to U.S. real estate investment trusts and real estate stocks. The sector fares better in a low-rate environment and yields high. With the Fed likely to cut rates in September, the sector should outperform. Vanguard Real Estate ETF VNQ yields 3.62% annually and charges 13 bps in fees.

Utilities ETFs

The Utility sector tends to be stable and provides consistent dividends. This sector also performs better in a low-rate environment. Utilities Select Sector SPDR ETF XLU charges 9 bps in fees and yields 2.11% annually.

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