FOMC Meeting: What’s Next for Bond ETFs?

The bond market expects more rate cuts beyond September.

CPI is history and all eyes are turning to next week’s FOMC meeting. 

Yesterday’s Consumer Price Index reported cooling inflation with data coming in mostly as expected. Will the numbers change market expectations about the Federal Reserve’s decision to cut interest rates? 

The CPI gained 0.2% in August, matching the 0.2% increase expected, while the highly watched inflation gauge cooled to 2.5% vs. the 2.9% increase in July. 

The core CPI, which strips out volatile food and energy prices, rose 0.3% in August, compared with 0.2% expected. 

As of Wednesday afternoon, just hours after the Bureau of Labor Statistics reported CPI, the CME Fed Watch tool, which tracks the Fed Funds Futures market, gave an 85% probability of a 25-basis-point rate cut at the next Federal Open Market Committee meeting, Sept. 17-18. 

Fixed income ETFs slowed their recent momentum, as the CPI all but eliminated expectations of a 50-basis-point rate cut, and the bond market proxy iShares 20+ Year Treasury Bond ETF (TLT) struggled to hold its nearly 14% two-week gain. 

The next move for bond ETFs depends largely on what happens after next week’s highly expected rate cut, which would be the first in over four years. 

Bond ETFs: Looking Beyond September’s FOMC Meeting

September’s FOMC meeting may as well be over, as market observers expect the Federal Reserve to remain data dependent, which Fed Chair Jerome Powell has consistently communicated in press conferences. This means that investors will look to coming labor market and inflation data, including the weekly jobless claims numbers and the next Personal Consumption Expenditures Price Index due Sept. 27, to gauge future rate hikes. 

The CME Fed Watch tool predicts at least 100 basis points of rate cuts by the end of the year, which explains the attraction to fixed-income investments in recent weeks, as bond prices have an inverse relationship to interest rates. Long-term bond ETFs like TLT stand to benefit more from cooling inflation and falling interest rates as longer maturities are more sensitive to rate moves. 

Ultimately, the broader capital markets, to include equities, would benefit most if the Fed can engineer the so-called soft landing, where inflation continues its steady decline toward 2.0% but the U.S. economy avoids slipping into a recession.