ETFs to Win or Lose on Hawkish Fed Minutes (Revised)

This story originally appeared on Zacks

The Federal Reserve’s latest meeting minutes came as optimism and revealed policy makers’ concern about worsening inflation. Members said the labor market is nearing full employment. The odds of a March rate hike rose 0.25% to 72%, according to Federal Reserve futures trading. If enacted, it would be the Fed’s first rate hike in three years to tackle inflation.

– Zacks

The US central bank has already accelerated quantitative easing. The central bank plans to buy $60 billion a month in Treasurys and agency mortgage-backed securities starting in January, down from $90 billion in December and $120 billion from the start of the pandemic through November. In addition, the bank raised its economic growth forecast, raised inflation expectations and lowered unemployment rate forecasts.

While officials have not made any plans about when the Federal Reserve will begin rolling out the roughly $8.3 trillion in Treasuries and mortgage-backed securities that it holds, statements from the meeting indicated that the process could begin in 2022, according to an article CNBC.

The meeting summary highlighted “nearly all participants agreed that it would likely be appropriate to begin the balance sheet return process at some point after the first increase in the target range for the federal funds rate.” With the prospect of a hawkish Fed in 2022, stocks are starting to fall and government bond yields are starting to rise.

Below, we’ve highlighted a few ETF winners and losers.

ETFs to Earn

SPDR S&P Bank ETF KBE

Banks are the beneficiaries of higher interest rates. As banks seek to borrow money at short-term rates and lend at long-term rates, the steep yield curve earns more on lending and pays less on deposits, resulting in a wider spread. This expands net profit margins and increases banks’ profits (read: 7 ETF forecasts for 2022).

iShares Floating Rate Bond Fund flute

The US Bloomberg floating rate base note <5 years includes US dollar-denominated floating rate bonds with residual maturities ranging from one month to five years. The fund charges a fee of 15 basis points.

High interest rate hedge from ProShares HYHG

The FTSE Core High Yield Index (Treasury Rate Hedge) consists of long positions in US dollar-denominated high-yield corporate bonds and short positions in US Treasuries or bonds of roughly equivalent duration. Such a method of hedging the interest rate puts the fund in a good position to play in an environment of rising rates. The fund charges a fee of 51 basis points and yields a return of 4.54% per annum.

Invesco S&P MidCap 400 Pure Value ETF RFV

Value funds usually fare better in a higher interest rate environment. Investors should note that undervalued stocks outperform growth stocks in a low-price environment. With the yield on 10-year Treasuries rising, there could be a shift from momentum to value stocks.

iShares Russell 2000 ETF etc.

Higher interest rates add strength to the US dollar. This will favor small cap stocks, which have the most exposure locally. Since these companies do not have much exposure to international markets, the appreciation of the US currency does not disturb their profitability.

ETFs are losing

Invesco QQQ QQQ

The Nasdaq posted its biggest daily drop since February after the minutes of the “hawkish” Federal Reserve meeting on January 5th. Since QQQ is technology-heavy and inherently high-growth, the Nasdaq-100 underlying index tends to underperform in a bullish price environment. Higher interest rates will affect equity multiples, especially for technology and other growth stocks.

ProShares Bitcoin Strategy ETF Beto

Bitcoin and other cryptocurrencies tumbled as global stocks came under pressure on hawkish Federal Reserve meeting minutes. In addition, the Securities and Exchange Commission (SEC) has postponed its decision on NYDIG’s spot Bitcoin ETF proposal. A high price environment is not beneficial for highly speculative assets like Bitcoin.

Vanguard MortgageBacked Securities ETF VMBS

The 30-year fixed-rate mortgage rate – the most popular home loan for homebuyers – rose from 3.11% to 3.22% this week, the highest level since May 2020, according to Freddie Mac, citing Yahoo. The rate is more than half a point higher than 2.65% from last year. No wonder, VMBS will likely underperform in the coming days.

iShares US Home Construction ETF ITB

Home builder stocks and ETFs may take a hit in the coming days due to the double whammy of rising home prices and rising mortgage rates. Although valuations are still cheaper for ETFs like ITB, the road ahead is littered with obstacles.

Utilities Select Sector SPDR ETF XLU

This is another interest rate sensitive sector. Utilities depend on debt, which will now become more expensive. In addition, the demand for yield in the utilities sector will now decrease as safe haven bonds are also yielding good returns.

(We are reissuing this article to correct an error. The original article released on January 7, 2022 should not be relied upon.)

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Invesco QQQ (QQQ): ETF Research Reports

iShares Russell 2000 ETF (IWM): ETF Research Reports

iShares US Home Construction ETF (ITB): ETF Research Reports

SPDR S&P Bank ETF (KBE): ETF Research Reports

Utilities Select Sector SPDR ETF (XLU): ETF Research Reports

Invesco S&P MidCap 400 Pure Value ETF (RFV): ETF Research Reports

iShares Floating Rate Bond ETF (FLOT): ETF Research Reports

ProShares High YieldInterest Rate Hedging (HYHG): ETF Research Reports

Vanguard MortgageBacked Securities ETF (VMBS): ETF Research Reports

ProShares Bitcoin Strategy ETF (BITO): ETF Research Reports

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Zacks Investment Research

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