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Signs of U.S. economic slowdown have prompted calls for a dovish pivot by the Federal Reserve, meaning it's time for investors to consider an ETF playbook for a scenario where rate cuts materialize.
The decision at the recent Federal Open Market Committee (FOMC) meeting to keep rates unchanged was followed by a deflated U.S. non-farm payroll print—114,000 new jobs added in July versus 175,000 forecast.
With some viewing this as a preliminary sign of recession risk and popular U.S. indices including the S&P 500 and Nasdaq 100 falling early last week, markets priced in as many as five cuts to the Fed funds rate, totaling 1.25%, by the end of the year.
While many fund selectors view such a dovish turn as unlikely, investors may want to consider which asset classes stand to pivot in a rate cutting environment after investors spent most of the year's first half pricing in ‘higher for longer’.
iShares $ Treasury Bond 20+yr UCITS ETF (DTLA)
A first ETF for investors’ rate cutting watchlists could be BlackRock’s $7.4bn DTLA, the largest ETF providing exposure to long-dated US government bonds.
DTLA carries a total expense ratio (TER) of 0.07% and physically replicates the ICE US Treasury 20+ Year Bond index of 40 US sovereign issuances with an effective maturity of 26 years.
Having plummeted 31.3% in 2022 amid rapid Fed rate hikes – and falling 0.2% in the first seven months of 2024 owing to high core price inflation prints in January – DTLA could be primed to benefit from Fed rate cuts.
Amid cooler CPI prints and recent payroll data, yields on 20-year US Treasuries have fallen from 4.74% to 4.32% in three months, as at 9 August, with DTLA returning 6.8% over the same period.
Its U.S. counterpart is the iShares 20 Plus Year Treasury Bond ETF (TLT).
Xtrackers S&P 500 Equal Weight UCITS ETF (XDEW)
Switching to equities, DWS’s $6.7bn XDEW could provide an ideal tool for moving down the US market cap spectrum as lower borrowing costs provide a catalyst for a broadening out of earnings.
Carrying a TER of 0.20%, XDEW equally weights the constituents of the S&P 500, providing a tilt towards mid-caps over the large cap bias of its parent index.
While the equal weight variant of the popular US benchmark might lag the performance of its market cap equivalent by around seven percentage points so far in 2024, XDEW amassed $744m inflows in the month to 9 August as investors looked to add US allocations outside of the ‘Magnificent Seven’.
In fact, if the Fed were to cut rates, not only would this benefit smaller companies which tend to have greater debt burdens, but lower borrowing costs could also catalyse higher consumer spending, while a relatively weaker US dollar would buoy US exporters.