Inflation, Rates Support Case for Floating Rate Notes | ETF Trends

Stubbornly high inflation and a solid economy — the former a negative, the latter a positive — may be conspiring to force the Federal Reserve to keep interest rates higher for longer. Entering this year, the consensus was the central bank would pare rates multiple times in 2024. More recently, market observers have dialed back expectations to include just one rate cut.

Some have gone as far as saying no such action will be taken by the Fed this year. One or no rate cuts would be considered disappointing. But exchange traded funds, such as the WisdomTree Floating Rate Treasury Fund (USFR), can ease that dismay.

As its name implies, USFR focuses on floating rate notes. That segment of the bond market is designed to be less sensitive to changes in interest rates. That methodology matters. Year to date, USFR is higher by 1.8%, while the Bloomberg U.S. Aggregate Bond Index is lower by almost 3%. Over the past three years, the period including the Fed’s tightening cycle, USFT gained 9.1%, while “the Agg” slumped 10.2%.

Data Confirms Utility of USFR

The pace at which inflation is rising is slowing and well off the highs seen in 2022. But some experts argue it’s not retreating enough to give the Fed the leeway with which to lower rates. That’s a strong factor in support of floating rate notes and ETFs like USFR.

“Having risen 0.7% month-on-month in the latest release, this ‘super core’ measure of inflation is now running above 8% on a three-month annualized basis. Looking at a broad range of measures, the reality is that inflation is currently running too hot for the Fed to feel comfortable easing monetary policy conditions in the near term,” noted Schroders.

The research firm added that with the March reading of the Consumer Price Index (CPI) coming in hotter than expected, the Fed will likely not trim rates in June as was previously hoped. That thesis, which is now wide-ranging, could underscore near-term opportunity with USFR.

Additionally, economic data in the U.S. is supportive of higher rates. With the labor market in a historically good place and U.S. GDP growth pacing well ahead of other industrialized economies, the Fed might be concerned about stoking hyperinflation by lowering interest rates. Those factors could add to the constructive case for USFR.

“Our base case anticipates a soft landing. However, we recognize increased risks of a ‘no landing’ scenario due to a series of US inflation surprises and a potential upturn in the global manufacturing cycle, which could bolster commodity prices. This situation might compel central banks to maintain higher interest rates for an extended period to combat persistent inflation,” concluded Schroders.

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