Fed Cuts Rates by 0.25%, Signals Fewer Cuts: ETFs to Play

As expected, on Wednesday, the Federal Reserve cut its benchmark interest rate by a quarter percentage point, marking the third successive reduction. The Federal Open Market Committee (FOMC) adjusted its overnight borrowing rate to a target range of 4.25%-4.5%, the level last seen in December 2022.

Despite the widely expected decision, markets focused more on the Fed's future guidance, especially as inflation remains above target. The Trump 2.0 era may push up inflation further and economic growth remains solid—conditions that typically do not support policy easing.

Limited Rate Cuts Expected in the Future

The Fed signaled only two additional cuts in 2025, according to its "dot plot" projections, a significant reduction from earlier expectations. Assuming quarter-point increments, two more cuts are anticipated in 2026 and one in 2027. Over the long term, the Fed projects a “neutral” funds rate of 3%, slightly higher than its September estimate.

Reacting to this hawkish Fed guidance, SPDR Dow Jones Industrial Average ETF Trust DIA lost 2.6% on Dec. 18, 2024. SPDR S&P 500 ETF Trust SPY shed about 3% on the day while Invesco QQQ Trust QQQ slumped 3.6%.

Treasury yields surged, with futures pricing adjusting to reflect fewer anticipated rate cuts in 2025, based on the CME Group’s FedWatch tool. The benchmark 10-year U.S. Treasury yield leaped to 4.5% as the Fed signaled caution on future rate cuts.

Revised Growth and Inflation Estimates

Despite cutting rates, the Fed revised its 2024 GDP growth projection upward to 2.5%, reflecting a stronger-than-expected economy. However, growth is expected to slow to 1.8% in subsequent years. Inflation projections also increased slightly, with headline inflation now estimated at 2.4% and core inflation at 2.8%—both above the Fed’s 2% target.

Labor Market Resiliency

The unemployment rate projection for 2024 was lowered to 4.2%, reflecting a robust labor market. However, hiring has shown signs of slowing, and inflation pressures appear to be easing, according to recent Fed reports.

Cautious Approach Amid Fiscal Uncertainty

Fed Chair Powell highlighted the importance of patience, especially as President-elect Donald Trump’s proposed policies—such as tariffs and tax cuts—could cause inflationary pressures. “We need to take our time, not rush and make a very careful assessment,” Powell said.

Efforts to Normalize Policy

The Fed has reduced its benchmark rate by a full percentage point since September, reflecting an effort to normalize policy. Despite aggressive rate cuts, market indicators like the two-year Treasury yield remain elevated, suggesting uncertainty about the Fed’s ability to enact further cuts.

ETFs to Gain

Against this backdrop, below we highlight a few exchange-traded funds (ETFs) that could be gainful in the coming days.

SPDR S&P Dividend ETF (SDY)

Due to an edgy market backdrop, it is intriguing to pick quality stocks at the current level. Persistent dividend growth can serve as one such quality measure. Stocks that hike dividends continuously are safe bets. Further dividend payments are expected to continue increasing in the coming months as most large U.S. companies are aflush with cash and in a position to increase payouts to their shareholders.

Invesco QQQ Income Advantage ETF (QQA)

As the artificial intelligence (AI) boom is in fine fettle, exposure to the Nasdaq-100 ETF QQQ is desirable. But a low volatility quotient makes sense if rates rise next year. The QQA ETF offers that layer of protection from downside.

The Invesco QQQ Income Advantage ETF seeks to provide investors exposure to the Nasdaq-100 Index combined with an active option income overlay for income generation, downside protection and upside participation. The ETF QQA yields 3.29% annually.

NEOS Russell 2000 High Income ETF (IWMI)

As the U.S. economy has been growing at a steady clip, the small-cap ETF IWM appears to be a good bet. This is especially true given that Trump’s protectionist agenda favors small-cap ETF investing. The ETF IWMI seeks to generate high monthly income in a tax-efficient manner with the potential for small-cap equity appreciation. The ETF IWMI yields 7.15% annually.

iShares Interest Rate Hedged High Yield Bond ETF (HYGH)

As there are chances of higher rates next year, bond ETFs that provide a cushion against rising rates, should perform well. The underlying BlackRock Interest Rate Hedged High Yield Bond Index mitigates the interest rate risk of a portfolio composed of U.S. dollar-denominated, high-yield corporate bonds. The ETF HYGH yields 8.05% annually. The HYGH ETF yields 8.05% annually.

iShares Short Treasury Bond ETF SHV

Since the Fed will be slashing rates in 2025, although at a moderate pace, shorter-term bond yields are likely to fall. This should boost price of short-term bond ETFs.

The underlying ICE Short US Treasury Securities Index intends to assess U.S. Treasury-issued debt. Only U.S. dollar-denominated, fixed-rate securities with minimum term to maturity greater than one month and less than or equal to one year are included. The ETF SHV yields 4.63% annually.

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