Soft Landing ETFs Price In Rate Cuts

As recession fears diminish, investors are buying shares of what they believe to be the best ETFs for a soft-landing scenario. 

But what exactly is a soft landing and which exchange-traded funds can benefit the most from this potential economic environment in 2024? 

What Is a Soft Landing in Economics?

A soft landing in economics refers to a scenario where a central bank, such as the Federal Reserve, successfully slows down an overheated economy without causing a recession. This typically involves raising interest rates gradually to manage inflation without triggering a significant downturn in economic activity. 

Whether or not the Fed can successfully engineer a soft landing, what’s clear is that investors are pricing one in now.  

Since late October, when investors began feeling more confident that the Fed is finished raising rates, we’ve seen significant price gains for rate-sensitive investments, such as long-term bond ETFs and growth stocks.  

For example, over the past five weeks, prices for long-term bond ETFs like the iShares Treasury Bond ETF (TLT) have risen more than 15% while technology stocks are up more than 14%, as measured by the Technology Select Sector SPDR (XLK).  

If the soft landing is being priced in now, how much softer does the landing need to be to enable stock and bond prices to rise further? 

Perhaps a better question to ask: Has the Fed ever engineered a soft landing? 

What Is an Example of a Soft Landing? 

The prime example of a soft landing was the one in 1994 under the guidance of then Fed Chairman, Alan Greenspan. Inflation was 2.8%, and the fed-funds rate was around 3%. With inflation rising and unemployment rapidly falling, the Fed was concerned about a potential rise in inflation and decided to raise rates preemptively. 

The Fed raised rates seven times in 1994, doubling the fed-funds rate to 6% from 3%. In 1995, the Fed cut rates three times, as it saw the economy slowing enough to hold off inflation. 

For perspective, the oldest U.S.-traded ETF, the SPDR S&P 500 ETF Trust (SPY), declined by about 2% in 1994.

Bottom Line on ETFs and Soft Landings 

In a soft landing economy, investors need to keep in mind that growth is slowing. For example, real gross domestic product, or GDP, increased at an annual rate of 5.2% in the third quarter of 2023, but the forecast for growth in 2024 is 1.5%. In an economy where growth is rapidly declining, growth stocks may not perform well.

Furthermore, the rapid price gains in long-term Treasury ETFs like TLT and tech ETFs like XLK indicate that investors may be expecting not only a soft landing in 2024 but rate cuts as well. However, rate cuts don't typically align with a soft landing; they'd more likely accompany a recession, which may further support bonds but would be generally negative for stocks.