The U.S. consumer inflation rate took a dip to touch 4.0% in May 2023, marking the lowest since March 2021 and slightly below market expectations of 4.1%. This decline was primarily driven by a decrease in energy prices, predominantly gasoline and electricity.

Energy costs fell 11.7%, while food inflation slowed to 6.7%. There were also smaller price increases of 4.7% for new vehicles, 3.5% for apparel, 8.0% for shelter, and 10.2% for transportation services. The cost of medical services was down 0.1%. On a sequential basis, consumer prices nudged up 0.1% in May.

Plus, the core rate, which bars volatile items such as food and energy, has slowed to 5.3%, the lowest since November 2021, making the case stronger for the Fed to opt for a pause in its current cycle of monetary tightening.

Against this backdrop, below, we highlight a few ETF areas that should gain in the near term.

ETF Areas in Focus

Total Market – iShares Core S&P Total U.S. Stock Market ETF (ITOT Quick QuoteITOT - Free Report)

Quite expectedly, the S&P 500 and the Nasdaq hit fresh 13-month highs as a decrease in inflation tends to favor stocks. A decline in inflation often triggers a slash in interest rates, which subsequently lowers borrowing costs and can potentially boost corporate earnings. Thus, well-managed inflation could bolster equity valuations.

Growth Sector – SPDR Portfolio S&P 500 Growth ETF (SPYG Quick QuoteSPYG - Free Report)

Growth sectors like technology often rely heavily on debt financing, making them particularly responsive to interest rate changes. As inflation moderates and interest rates remain low or steady, these firms can secure less expensive borrowing to fuel their growth. This can potentially lead to enhanced profitability and an uptick in their stock prices.

Regional Banks – iShares U.S. Regional Banks ETF (IAT Quick QuoteIAT - Free Report)

As the chaos created from bank failures in March 2023 settled down, regional bank stocks bounced back with immense force, due to easing banking volatility. These stocks are now trading at about a seven-week high. Expectations of a less-hawkish policy from the Fed amid a slowdown in inflation increased the attractiveness of regional bank ETFs (read: Regional Bank ETFs: Value Play or Value Trap?).

Small-Caps – iShares Russell 2000 ETF (IWM Quick QuoteIWM - Free Report)

Small-cap stocks and ETFs have been gaining strength lately on the signing of the debt deal, upbeat U.S. jobs data and chances of no rate hike this week. A decline in inflation has strengthened the case for a less-hawkish Fed this week, thus boosting small caps even more (read: 4 Reasons to Bet on Small-Caps ETFs).

Real Estate – Vanguard Real Estate ETF (VNQ Quick QuoteVNQ - Free Report)

While the sector is struggling from business pressure in commercial real estate space, the latest May inflation data bodes well for the sector. A low rate is a boon for this high-yielding space. Furthermore, real estate companies, known for their substantial debt loads, can fund their operations at lower costs when interest rates are low. The fund VNQ yields 4.13% annually.

Consumer Discretionary – Consumer Discretionary Select Sector SPDR ETF (XLY Quick QuoteXLY - Free Report)

Decreased inflation typically results in enhanced consumer purchasing power, potentially uplifting the consumer discretionary sector's performance. This sector includes companies that offer non-essential items. With more disposable income, consumers are likelier to indulge in these kinds of products and services.

Highly-Rated Corporate Bonds – iShares IBoxx $ Investment Grade Corporate Bond ETF (LQD Quick QuoteLQD - Free Report)

In an environment with lower inflation, the worth of fixed-income securities such as bonds usually rises. The reason for this is that the Fed is less likely to hike rates in a low rate environment. If rates or yields of bonds are low, price of bonds will jump. The fund LQD yields 3.71% annually.