Signs of US economic slowdown have prompted calls for a dovish pivot by the Federal Reserve, meaning it is time for investors to consider an ETF playbook for a scenario where rate cuts materialise.
The decision at the recent Federal Open Market Committee (FOMC) meeting to keep rates unchanged was quickly followed by a deflated US non-farm payroll print – with 114,000 new jobs added in July versus 175,000 forecast.
With some viewing this as a preliminary sign of recession risk and popular US indices including the S&P 500 and Nasdaq 100 shedding over 3% apiece last Monday, markets priced in as many as five cuts to the Fed funds rate, totalling 1.25%, by the end of the year.
While many fund selectors view such a dovish turn as unlikely, it still bears considering which asset classes could stand to pivot in a rate cutting environment after investors spent most of H1 pricing in ‘higher for longer’.
1. 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.
2. 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.
3. Amundi US Curve Steepening 2-10Y UCITS ETF (STPU)
Turning back to government bonds, Amundi’s $1bn STPU could offer investors a technical instrument to play the normalisation of the US Treasury yield curve.
STPU carries a TER of 0.30% and tracks the Solactive USD Daily (x7) Steepener 2-10 index, a benchmark comprised of leveraged long and short positions on 1-3 year Treasuries and 7-10 year Treasuries, respectively.
In practice, this leveraged ETF should benefit from yields on short-dated Treasuries by capturing seven-times leveraged exposure to the upside of short-dated issuance and vice versa for issuance in the middle of the yield curve.
Benefitting from similar dynamics to DTLA, STPU returned 1.9% in the three months to 9 August.
4. Xtrackers USD High Yield Corporate Bond UCITS ETF (XUHY)
Moving into credit, high-yield corporate bond plays such as XUHY may be attractive as the prospect of rate cuts sees spreads widen to their widest point since November 2023.
XUHY carries a TER of 0.20% and physically replicates the Bloomberg Barclays US High Yield Very Liquid index ex 144A of 818 US dollar-denominated, high-yield corporate issuances with at least $500m outstanding and less than 15 years to maturity.
Spreads widening in recent weeks suggest investors may finally be rewarded for moving down the credit spectrum after not being paid for taking on additional default risk for most of H1.
Illustrating this, some fund selectors told ETF Stream they have begun closing their underweight positions in high-yield credit, with the high-yield ETF product range welcoming $600m new assets in July.
5. iShares US Property Yield UCITS ETF (IUSP)
Finally, investors could target the comeback of the interest rate-hampered real estate sector with BlackRock’s IUSP.
The ETF carries a TER of 0.40% and physically replicates the FTSE EPRA/NAREIT United States Dividend+ index of 95 US real estate companies and real estate investment trusts (REITs) with a one-year dividend forecast of at least 2%.
After suffering on the back of Fed hawkishness in 2022 – which spelled lower property prices and higher borrowing costs for REITs – IUSP returned 12% in the three months to 9 August in anticipation of easing monetary conditions.
Additionally, the ETF’s 3.15% dividend yield for the trailing 12 months looks more attractive in the context of lower interest rates.
