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The respective central banks of Canada, England, the European Union, New Zealand, Switzerland, and Sweden have cut rates this year. Based on the current probabilities listed on the Fed Rate Monitor Tool on Investing.com, market participants and onlookers are anticipating, if not hoping, that the Federal Reserve will do the same in its September 2024 meeting. Investors' growing anticipation and hope are not unwarranted, as the latest inflation figures have come in slightly under 3% (i.e., 2.9%), the lowest since March 2021. Furthermore, the rise in unemployment is another indicator used as a basis for lowering rates.

Given the incoming data and the market events in early August, the upcoming Federal Reserve Jackson Hole symposium will have elevated significance. Investors will be looking for any indication or confirmation as to whether the Federal Reserve will lower rates in September 2024, by how much, and if subsequent reductions will possibly occur later in the year.

Ironically, the anticipation and postulation about the Federal Reserve lowering rates raise a compelling question: How can investors position and capitalize for this impending change?

ETFs To Consider Should The Fed Reduce Rates

Fixed Income

Given the inverse relationship between bond yields and price, bond ETFs, specifically intermediate and long-term bonds, are poised to benefit from a rate reduction, given their sensitivity to changes in the interest rate environment. With rates having peaked in the U.S., there is an expectation for yields to fall and for price return to be a positive driver going forward. For investors interested in intermediate and long-term bonds, the following are worth consideration:

iShares 1-5 Year U.S. IG Corporate Bond Index ETF (CAD-Hedged) (Ticker: XIGS)

XIGS is a passively managed strategy replicating the ICE BofA 1-5 Year U.S. Corporate Index (CAD-Hedged), composed of U.S. dollar-denominated, investment-grade corporate bonds with remaining maturities between one and five years. This solution gives investors access to 2000+ high-quality corporate bonds in a single fund.

As of July 31, 2024, the fund’s 1-year performance has been 12.00%, while year to date has been 7.90%

BMO Mid-Term U.S. IG Corporate Bond Index ETF (Tickers: ZIC/ZIC.U)

ZIC (or ZIC.U) is a passively managed strategy that replicates the Bloomberg Barclays U.S. Investment Grade 5-10 Year Corporate Bond Index, which consists of United States dollar-denominated, investment-grade, fixed-rate, taxable corporate bonds between 5 and 10 years until maturity. Through this solution, investors gain access to a diversified portfolio of U.S. corporate bonds and will receive consistent income.

As of July 31, 2024, the fund’s 1-year performance has been 12.71%, while year to date has been 6.79%

Equities

While a reduced-rate environment is advantageous for bonds, it also benefits equities. Research conducted by Schroders Asset Management highlighted that one year after the US Federal Reserve starts cutting interest rates, the average return from U.S. stocks is approximately 11%, outperforming bonds and cash. These findings were based on long-term analysis of f investment returns during 22 US interest rate-cutting cycles since 1928.

Considering Schroder’s findings, a reduction in interest rates would likely not affect all companies equally. Given that small and mid-capitalization companies are more interest-rate sensitive than large-capitalization companies due to higher debt levels (relative to their assets) and are likely more susceptible to economic changes, a reduced interest-rate environment might have an outsized impact on their equity performance.

Though the performance of large-cap equities, namely the Magnificent Seven, has been driving the performance of U.S. equity markets, U.S. Small-cap equities have exhibited compelling performance, and a reduced interest rate environment could push them further. For investors seeking exposure to this particular asset class, the following ETFs are worth consideration:

TD Q U.S. Small-Mid-Cap Equity ETF (Ticker: TQSM) seeks to achieve long-term capital growth by using a quantitative approach to security selection to invest primarily in, or gain exposure to, equity securities of small or medium-sized issuers in the United States. The quantitative equity strategy will generally result in a portfolio of investments in many securities broadly diversified across all sectors. Furthermore, the strategy aims to optimize exposure to stocks that are expected to outperform the overall market while factoring in implementation costs and seeking to avoid uncompensated risks.

As of July 31, 2024, the fund’s 1-year performance has been 25.68%, while year to date has been 17.23%

BMO S&P US Small Cap ETF (Ticker: ZSML) has been designed to replicate the performance of the S&P SmallCap 600® Index. The ETF invests in and holds the Index's constituent securities in the same proportion as they are reflected in the Index.

As of July 31, 2024, the fund’s 1-year performance has been 18.93%, while year to date has been 14.36%

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.