Introduction to Interest Rates
Federal Reserve Governor Christopher Waller may have just given ETF investors a surprising turn of events in the middle of summer. In a recent interview with CNBC, Waller mentioned that the U.S. central bank could start cutting interest rates as early as July. This is a significant change after six straight months of keeping rates steady.
What This Means for the Economy
The Federal Open Market Committee (FOMC) is set to meet on July 29-30, and while a rate cut is not guaranteed, Waller’s comments have given markets, especially rate-sensitive ETFs, new speculation to consider. Waller noted that inflation and GDP are now near the Fed’s long-term targets, and he estimated that the current benchmark rate is about 1.25 to 1.5 percentage points above the "neutral" level. This suggests that the Fed might have tightened rates too much and could be ready to ease up.
Sectors That Could Benefit from Rate Cuts
Several sectors could see a boost if the Fed decides to cut interest rates. These include:
- Real Estate ETFs: Real estate investment trusts (REITs) are highly sensitive to interest rate changes because they rely heavily on financing. A rate cut could boost real estate ETFs like the Vanguard Real Estate ETF (VNQ) and the iShares U.S. Real Estate ETF (IYR).
- Utilities ETFs: Utility stocks are often seen as bond proxies due to their stable dividends and tend to outperform when rates fall. If the Fed eases rates, utilities ETFs like the Utilities Select Sector SPDR Fund (XLU) could attract investors seeking higher yields.
- Tech and Growth ETFs: Lower interest rates increase the net present value of future earnings, which is beneficial for growth-focused ETFs. High-duration tech plays in funds like the Invesco QQQ Trust (QQQ) and the ARK Innovation ETF (ARKK) could see gains as the cost of capital decreases and investor risk appetite increases.
- Bond ETFs: Treasury ETFs with longer durations could rally on falling yields, especially if the Fed signals a steady easing cycle. The iShares 20+ Year Treasury Bond ETF (TLT) has already seen some upward price movement in anticipation of policy shifts.
The Fed’s Divided Stance
Despite Waller’s optimism, not all Fed officials agree on cutting rates. At the last policy meeting, seven officials indicated they expect no cuts this year, according to Bloomberg. Others predict two cuts before the year’s end. Geopolitical factors, such as Middle East tensions that could reignite inflation, also play a role in the Fed’s decision-making.
Inflation and Commodities
Given these uncertainties, inflation hedge ETFs like the iShares TIPS Bond ETF (TIP) or broad commodity funds like the Invesco DB Commodity Index Tracking Fund (DBC) might still be valuable in a diversified investment strategy.
Political Influences
President Donald Trump has been critical of the Fed, urging it to cut rates to reduce the government’s interest costs on its debt. However, Waller made it clear that the Fed’s mandate is to focus on unemployment and price stability, not to provide cheap financing to the U.S. government.
Conclusion
Waller’s comments suggest the Fed is becoming more comfortable with the idea of normalizing interest rates. For ETF investors, this means considering sectors that could benefit from falling rates, while also keeping an eye on the ongoing inflation story and geopolitical factors. As the economic landscape continues to evolve, staying informed about potential shifts in monetary policy will be crucial for making informed investment decisions.
