February volatility has replaced January’s steady climb, as artificial intelligence disruption fears triggered a broad “risk-off” mood across markets. But softer inflation data has shifted attention back to monetary policy — and whether the Federal Reserve could begin cutting rates by mid-year.

Inflation Cools, Cut Expectations Rise

January’s Consumer Price Index showed headline inflation rising 2.4% year over year, down from 2.7% in December. Core CPI came in at 2.5%, its lowest reading since 2021 and slightly below expectations.

Following the report, interest-rate futures strengthened their outlook for easing. According to market pricing, there is now roughly a 70% chance of a June rate cut, up from 64% before the CPI release. By July, odds climb above 80%.

If inflation continues trending lower without a sharp economic slowdown, the Fed could gain flexibility to reduce borrowing costs while maintaining credibility on price stability.

Small-Cap ETFs: Leverage to Lower Rates

Small-cap stocks are typically more sensitive to interest-rate moves because they rely heavily on external financing. Lower borrowing costs can ease debt burdens and support expansion plans.

Investors may consider:

• iShares Core S&P Small-Cap ETF
• iShares Russell 2000 ETF
• Vanguard Small-Cap ETF

Among these, VB is one of the lowest-cost options in the category, while IJR has recently outperformed over shorter time frames.

Small caps often outperform in early stages of monetary easing cycles, particularly when growth expectations remain intact.

Financial ETFs: Credit Expansion Catalyst

Financial institutions can benefit from rate cuts if lower borrowing costs stimulate loan growth and business activity. Although banks faced sentiment-driven pressure amid AI disruption concerns, fundamentals remain intact in many diversified institutions.

Relevant ETFs include:

• Financial Select Sector SPDR Fund
• Vanguard Financials ETF
• iShares U.S. Financials ETF

XLF is widely used for broad financial exposure and remains among the most cost-efficient options in the sector.

If easing coincides with stable economic growth, financials could experience renewed momentum.

Utility ETFs: Defensive Yield Play

Utilities are capital-intensive businesses that benefit from lower financing costs. They are also considered defensive investments, often attracting capital when volatility rises.

Investors may explore:

• Utilities Select Sector SPDR Fund
• Vanguard Utilities ETF
• iShares U.S. Utilities ETF

Utilities combine potential rate sensitivity with dividend income, making them appealing if economic uncertainty persists.

Bottom Line

Rate-cut expectations are strengthening as inflation moderates. If June easing materializes, cyclical and rate-sensitive sectors could benefit first, particularly small caps and financials. Meanwhile, utilities offer a defensive cushion with income support.

Investors should monitor upcoming inflation data and Federal Reserve communications closely, as policy shifts could quickly reshape sector leadership in 2026.