What the Fed’s rate cut could mean for ETF investors

The Federal Reserve (Fed) injected a fresh wave of cheer into markets with its first interest cut in more than four years.

At its 18 September meeting policymakers lowered the benchmark rate by a bumper 50 basis points (bp), taking it to a 4.75%-5.0% range.

The Fed’s quarterly summary of economic projections, published alongside the meeting, heightened the mood further as it showed the Fed expects, in the wake of fading inflationary pressures, another 50bp of cuts this year and 100bp of cuts in 2025.

This was clearly the news markets had been waiting for as US stocks soared to record highs. The US blue-chip S&P 500 index closed at its highest level since July, the Dow Jones Industrial Average finished above 42,000 for the first time and the technology-heavy Nasdaq also made gains.¹  This has been good news for ETF US exposures across asset classes but there is still plenty for investors to weigh up over the coming months.

Markets remain on track

Despite the market cheer, it has not been an easy ride for ETF investors recently, as the traditionally quiet August period endured a spike in volatility – partly in response to labour market data.

But both equity and credit markets rebounded quickly while risk indicators – such as the VIX, or so-called fear index – swiftly reverted to their more benign lower levels.

Overall, the rout was not so serious as to derail US markets’ robust year-to-date performance, where the S&P 500 and Nasdaq each boast total returns of 21%.²

Looking ahead, markets suggest we are heading towards a 3% Fed Funds Rate. That path is guided by softer economic data and the slow return of inflation towards central bank targets.

It is good news for ETF investors as fixed income and equity returns will be sustained by easier money, which also offers some assurance that slower economic softness does not turn into a recession.

Additional bouts of market volatility cannot be ruled out in the months ahead given the market’s sensitivity to economic data. And volatility could well be driven by the US presidential election and its aftermath as well as ongoing geopolitical events. Certainly, a Donald Trump win, given his policy agenda - a mix of protectionism and tax cuts - could prove unsettling to both growth and inflation. A Kamala Harris win would likely prove less disruptive.

2024’s last lap

But for now, the Fed has started its interest rate cutting cycle - following moves from other central banks – and second quarter corporate earnings largely met growth expectations.

Strong returns from both equity and bond ETF exposures should potentially be sustained into the end of 2024. The yield on fixed income remains quite attractive and should become more attractive compared to cash in the months ahead, while we expect growth stocks will potentially lead the way for the equites - as they have for the whole of the year.

High yield and other short-duration fixed income credit ETF strategies most likely offer the lowest risk path to sustaining positive returns in the final semester of the year – and US high yield remains one of our favoured asset classes into year-end.