The Federal Reserve's 25 basis-point cut to its benchmark interest rate this week is likely the first in a new easing round from the central bank, given slowing job growth.
The signals that further trimming is coming this year and beyond may leave investors wondering what portfolio moves to make as interest rates decline.
We asked Bryan Armour, Morningstar's ETF and passive strategies research director for North America, to identify exchange-traded funds that should do better in a declining interest rate environment. He cited three of Morningstar's favorite bond ETFs and three among its favorite small-cap stock ETFs.
"Fixed-rate bonds typically benefit from declining interest rates. Duration measures interest rate sensitivity, so longer-duration bonds theoretically benefit most when rates fall. Be careful loading up on long-term bonds, though. Rate cuts aren’t necessarily felt equally along the yield curve. For example, 30-year Treasury yields have increased about 60 basis points since the start of 2024 despite 1.25-percentage-points of cuts to the federal funds rate during that time," he told Think Advisor in an email.
"Not every investor needs income. In fact, it’s inefficient to generate income, pay taxes on it, then reinvest it. A more efficient approach for investors without income needs is to hold small-cap stocks. These companies have less pricing power than large-caps and typically pay higher interest rates on debt, so declining interest rates can make small-cap stocks more profitable," Armour said.
See the gallery for six ETFs that could be appealing for clients. Data provided is from Morningstar.com.
Images: Chris Nicholls/Touchpoint Markets
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