More Fed Rate Cuts in 2026? ETFs to Play the Opportunities

Recent inflation data, expectations of a Fed chair appointment favoring rate cuts and comments from Fed Governor Christopher Waller have increased the likelihood of rate cuts beyond what markets may have priced in.

According to the CME FedWatch tool, markets are anticipating a 25.5% likelihood of interest rates being lowered to 3.25-3.5% in its January 2026 meeting, up from a 15.3% likelihood just a month earlier.

Softer Inflation Fuels Hopes of Earlier Rate Cuts

Softer U.S. inflation data have strengthened bets on two or more Fed rate cuts in the coming year, according to Yahoo Finance. Per Bureau of Labor Statistics data, as quoted on the abovementioned article, November’s underlying inflation grew at the slowest pace since early 2021, with headline CPI rising 2.7% year over year, below forecasts.

Per Fed Chicago President Austan Goolsbee, as quoted on Reuters, the latest CPI data was encouraging and, if sustained, could support the case for additional rate cuts next year.

Fed Leadership Shift Could Steer the Fed Toward More Rate Cuts

Recent comments from President Trump, suggesting that the next Fed chair will strongly favor lower interest rates, add to growing market bets on additional rate cuts next year, beyond earlier expectations, as per Reuters.

Trump has long advocated for lower interest rates, signaling plans to name his preferred successor early next year.

Waller Comments Reinforce Dovish Market Bets

Fed Governor Christopher Waller, a potential successor to Jerome Powell, again struck a dovish tone on interest rates. As quoted in another Reuters article, Waller recently commented that the Fed still has room to ease interest rates, citing signs of weakening in the labor market.

Waller, considered one of the possible successors to Jerome Powell, indicated that additional interest rate cuts might be at a moderate pace.

ETFs to Explore

Lower interest rates typically reduce borrowing costs, making it easier for companies to expand their business and increase profitability, which, in turn, boosts economic growth and the stock market. Below, we have highlighted ETFs that investors may consider if the Fed delivers more rate cuts in 2026.

Financial ETFs

The anticipated Fed interest rate cuts in 2026 should provide a meaningful tailwind for the sector and the fund, as this could lower capital costs for banks. Within the financial sector, banks with diversified operations could see stronger loan activity as rates decline.

In addition to interest rate cuts, 2026 could prove to be a meaningful year for financial ETFs supported by improving credit demand and robust capital market activity. The Dow Jones U.S. Financial Services Index has gained 19.70% over the past year and 2.41% month to date.

Investors can consider State Street Financial Select Sector SPDR ETF XLF, Invesco KBW Bank ETF KBWB, Vanguard Financials ETF VFH and iShares U.S. Financials ETF IYF.

Consumer Discretionary ETFs

Lower interest rates improve consumer access to credit and boost spending power, supporting profit margins in the consumer discretionary sector. Meanwhile, the capital-intensive utilities sector also benefits from falling rates through lower financing costs. The S&P 500 Consumer Discretionary Index has increased 7.17% year to date and 2.47% month to date.

Funds like State Street Consumer Discretionary Select Sector SPDR ETF XLY, Vanguard Consumer Discretionary ETF VCR, Fidelity MSCI Consumer Discretionary Index ETF FDIS and First Trust Consumer Discretionary AlphaDEX Fund FXD can be considered.

Small-Cap ETFs

Being heavily dependent on external borrowings, small-cap stocks could massively benefit from lower interest rates, which could increase their capital availability. Reduced rates also allow these companies to refinance existing debt at a cheaper rate, enabling them to invest in growth and expansion.

Investors can consider iShares Core S&P Small-Cap ETF IJR, iShares Russell 2000 ETF IWM, Vanguard Small Cap ETF VB and Schwab U.S. Small-Cap ETF SCHA.

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This article originally published on Zacks Investment Research (zacks.com).

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