The Fed Has a New Boss, Inflation Is at a 3-Year High, and Rate Cuts Look Unlikely. These Stocks Win in That Environment.

How quickly the investing environment can change.

Just a few months ago, markets were expecting the Federal Reserve to cut its benchmark interest rate two or even three times by the end of 2026.

Suddenly, that thinking seems very dated, and today investors face an entirely different reality.

First, of course, the Fed has a new boss. Kevin Warsh was confirmed by the Senate last week and will be sworn in as the 17th Federal Reserve Chair sometime this week.

There's some uncertainty around what Warsh will do differently from his predecessor, Jerome Powell. The new Fed chief talked about cutting rates in recent months, but rising inflation now makes rate cuts seem highly unlikely.

Inflation hit a three-year high of 3.8% in April, mostly due to the oil shock triggered by the war with Iran. Energy costs jumped almost 18% year over year.

Image source: Getty Images.

As a result, futures traders are now pricing in a 26% chance that the Fed's next policy move is a rate hike, not a cut, and a 74% chance that the Fed remains on hold through year-end -- no rate hike or cut. The bond market also expects a hawkish pivot from the Fed.

It's a jarring new reality for investors who just months ago expected the Fed to begin cutting rates in the coming months.

Some sectors and stocks flourish in rising inflation and rate environments

Fortunately, some sectors and stocks do well in an environment of rising inflation and potentially higher interest rates.

Oil and gas companies are among them. Energy is a major component of inflation indexes (again, it's the primary driver of inflation today), and energy stocks tend to perform well when energy prices are higher.

The State Street Energy Select Sector SPDR ETF (NYSEMKT: XLE), which tracks the entire S&P 500 energy sector, is up 34% year to date (for comparison, the S&P 500 index has climbed about 8.2% this year).

Financial institutions like banks and insurance companies benefit when the Fed raises rates because they can charge higher interest on loans and improve their net interest margins, the difference between the rate they borrow money at and the rate they lend at.

That sector, as measured by the State Street Financial Select Sector SPDR ETF (NYSEMKT: XLF), is down for the year, but its largest holdings, including Berkshire Hathaway (NYSE: BRKB) and JPMorgan Chase (NYSE: JPM), could do well in a high-inflation, rising-rate landscape.

Finally, real estate has always been a smart inflation hedge. Real estate investment trusts (REITs) tend to outperform inflation and post strong returns during periods of rising prices because they're able to pass price increases on to customers via increases in rental contracts and property prices.

There are hundreds of publicly traded REITs, but you can also invest in an index fund such as Vanguard Real Estate ETF (NYSEMKT: VNQ).

If inflation continues to rise and futures and bond markets are correct that the Fed's next move is a hike, energy, financials, and real estate may be the best bets to protect your portfolio.

JPMorgan Chase is an advertising partner of Motley Fool Money. Matthew Benjamin has positions in Berkshire Hathaway and Select Sector SPDR Trust-State Street Energy Select Sector SPDR ETF. The Motley Fool has positions in and recommends Berkshire Hathaway and JPMorgan Chase. The Motley Fool has a disclosure policy.