By Suzanne McGee

(Reuters) – U.S. exchange-traded funds (ETFs) that invest in dividend-paying stocks have enjoyed a rush of inflows since the Federal Reserve kicked off its rate cutting cycle last month, though a jump in U.S. Treasury yields could slow the deluge of investor funds.

The group of 135 U.S. dividend ETFs tracked by Morningstar pulled in $3.05 billion in September, the same month the Fed cut interest rates by 50 basis points, its first reduction since 2020. That compares to average monthly inflows of $424 million in the first eight months of 2024.

Their newfound popularity has been driven by investors seeking income-generating products ahead of declines in yields that are expected to occur as the Fed continues cutting interest rates.

"The pivot in monetary policy translates into cash looking for new homes, and dividend-yielding stocks will be one of the beneficiaries," said Nick Kalivas, head of factor and equity ETF strategy at Invesco.

Whether the trend continues remains to be seen: benchmark 10-year Treasury yields have shifted higher in recent weeks and hit two-month highs on Friday, after a blowout U.S. employment number pointed to a resilient economy that likely does not need the Fed to deliver more large cuts this year.

Still, Josh Strange, founder and president of Good Life Financial Advisors of NOVA, said the revival of interest in dividend stocks is a reaction to rising valuations in sectors such as tech as well as in broader markets, in addition to shifts in monetary policy.

At 21.5 times future 12-month earnings estimates, the S&P 500's valuation is near its highest level in three years and is well above its long-term average of 15.7, according to LSEG Datastream.

"The S&P 500 has become increasingly concentrated in just a few names, and the momentum has all concentrated around AI, making these stocks look frothy," Strange said.

Yields offered by dividend ETFs vary by strategy, but can range from just under 2% to as much as 3.6%. By comparison, benchmark 10-year Treasuries yield fell to around 3.6% in September.

Energy and financial stocks often appear in dividend ETFs, including Chevron Corp., JP Morgan Chase and Exxon Mobil. But they also feature pharmaceutical companies like Proctor & Gamble, utilities such as Verizon (VZ.N> or Southern Co. and retailers like Home Depot.

"If you seek out high dividend payouts, you're making a tradeoff: you also want to own companies that will grow and be capable of increasing those payouts," said Sean O'Hara, president of Pacer ETFs, discussing the outlook for dividend ETFs and related products in the latest edition of Inside ETFs.

To lessen the risk of owning companies with deteriorating fundamentals, Pacer builds ETF portfolios based on companies' free cash flows, such as the $24.8 billion Pacer US Cash Cows ETF, launched in 2016. It has attracted $7.1 billion in inflows in the last 12 months.

(Reporting by Suzanne McGee; Editing by Ira Iosebashvili and Deepa Babington)