Will the Fed Opt for a Hefty Rate Cut? ETF Strategies to Follow

The Federal Reserve’s September meeting revealed an internal debate on the size of its first interest rate cut in over four years. While a "substantial majority" of officials supported a 50-basis-point reduction, some preferred a smaller 25-basis-point cut. The minutes from the meeting highlighted the conflicting perspectives.

Case for a Smaller Rate Cut

Those in favor of a 25-basis-point cut cited still-elevated inflation, alongside strong economic growth and low unemployment. They believed a smaller and more gradual rate cut would allow time to assess its economic impact. This group prefers a measured approach.

Note that the consumer price index increased a seasonally adjusted 0.2% in September, putting the annual inflation rate at 2.4%. Both were 0.1 percentage point higher than forecast. A gradual approach would probably help manage inflation better.

Case for a Larger Rate Cut

Proponents of the 50-basis point cut argued that a more substantial reduction would help maintain economic strength and support the labor market (which showed signs of cooling occasionally) while continuing to tame inflation. Some officials believed that a larger cut was overdue.

Fed's Decision and Disagreement

Despite internal disagreement, the Federal Reserve ultimately chose to cut rates by 50 basis points. But the decision marked a shift-away from two years of unanimous decisions, with no Fed governor having dissented on a rate decision since 2005.

The Fed’s rate-setting committee does not share a unanimous view on the path forward, with nearly half of the members supporting one additional 25 basis point cut by year-end, while others favored two more cuts of 50 basis points each.

Two policymakers believed no further cuts were necessary. Powell, in remarks on Sept. 30, echoed this sentiment, stating that the Fed is not in a hurry to lower rates rapidly (read: Forget Growth or Value: Try Blend ETFs as Fed in no 'Hurry' to Cut Rates).

Latest Strong Jobs Data May Not Support Larger Rate Cut

A stronger-than-expected jobs report released shortly after the decision has raised concerns about whether the central bank moved too fast with the 50-basis point cut. Some analysts worry that inflation could become a renewed concern, especially given the latest rally in oil prices, causing caution over future rate cuts.

ETF Strategies to Follow

U.S. benchmark treasury yields closed at 4.09% on Oct. 10 2024, up from 3.74% recorded at the start of the month. Given this, investors must be interested in finding out all possible strategies to weather a rise in interest rates. For them, below we highlight a few exchange-traded fund (ETF) investing tricks that could gift investors with gains in a rising rate and uncertain environment (read: ETF Strategies to Follow Amid Rising Treasury Yields).

Tap Senior Loan ETFs

Senior loans are floating rate instruments that provide protection from rising interest rates.  This is because senior loans usually have rates set at a specific level above LIBOR and are reset periodically which help in eliminating interest rate risk. Further, as the securities are senior to other forms of debt or equity, senior bank loans offer lower default risks even after belonging to the junk bond space.

Virtus Seix Senior Loan ETF SEIX, which yields about 8.78% annually and Invesco Senior Loan ETF BKLN, which yields 8.62% annually are good picks here.

Play Floating Rate Bond ETFs

The floating rate bond has been an area to watch lately amid rising rate environment. Floating rate bonds are investment grade and do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of issuers.

Since the coupons of these bonds are adjusted periodically, these are less sensitive to an increase in rates compared to the traditional bonds. Unlike fixed-coupon bonds, these do not lose value when the rates go up, making the bonds ideal for protecting investors against capital erosion in a rising rate environment.

iShares Floating Rate Bond ETF FLOT (yields 5.94% annually) and iShares Treasury Floating Rate Bond ETF TFLO (yields 5.41% annually) are two examples in this category.

Play Buffer ETFs

Buffer ETFs are a type of ETF that aims to protect investors from a certain percentage of market losses (the "buffer") while still allowing for some participation in market gains. A buffer ETF provides protection up to a certain level of loss over a specific time period. These ETFs also cap the potential gains.

These funds are designed for investors who want some downside protection but don't want to miss out on potential market growth entirely. This is a good option to weather uncertainties in the market (read: Fearing Uncertainty in Wall Street? Buffer ETFs May Help).

Examples of such ETFs are Innovator U.S. Equity Power Buffer ETF – July PJUL, FT Vest U.S. Equity Buffer Fund – February FFEB, Innovator U.S. Equity Power Buffer ETF – September PSEP and AllianzIM U.S. Large Cap Buffer20 Jul ETF JULW.

Bet on Quality

Quality investing seems to be a solid bet. Quality stocks possess a sustainable competitive advantage and demonstrate consistent growth, profitability and operational excellence over time. These stocks are rich in value characteristics with a healthy balance sheet, high return on capital, low volatility, elevated margins and a track of stable or rising sales and earnings growth.

Among the most popular are iShares MSCI USA Quality Factor ETF QUAL, Invesco S&P 500 Quality ETF SPHQ, JPMorgan U.S. Quality Factor ETF JQUA.

Emphasis on Dividends

Dividend-paying securities are the major sources of consistent income for investors when returns from the equity market are at risk. This is especially true as these stocks offer the best of both worlds — safety in the form of payouts and stability in the form of mature companies that are less volatile to the large swings in stock prices.

The companies that pay dividends generally act as a hedge against economic uncertainty and provide downside protection by offering outsized payouts or sizable yields on a regular basis. Investors can bet on dividend growth ETFs like SPDR S&P Dividend ETF SDY and high-dividend ETFs like Vanguard High Dividend Yield ETF VYM.

Want key ETF info delivered straight to your inbox?

Zacks’ free Fund Newsletter will brief you on top news and analysis, as well as top-performing ETFs, each week.

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

To read this article on Zacks.com click here.

Zacks Investment Research