After keeping the interest rates at near zero levels for seven years, the Fed is expected to exit the historic loose monetary-policy era at the FOMC meeting to be concluded later today.
Per the latest Wall Street Journal poll, about 97% of the economists believe that the Fed will raise rates today while the rest expect the Fed to wait until next year. The probability of lift-off today is 87% as per private economic forecasters and 83% according to CME Group. Since the Fed has indicated a gradual path for rates hike, the market is speculating at least a quarter percentage point increase in interest rates today (read: ETF Tactics for a Rate-Proof Portfolio).
The Fed officials gave strong signals of a December lift-off in recent months. This is especially true, as the U.S. economy has now emerged from the financial crisis and the Great Recession, and is on a firmer footing. With back-to-back months of solid jobs growth, unemployment rate at a seven-year low and moderate inflation, chances of the first rate hike in almost a decade is now looking more real.
Additionally, stepped-up economic activities, rising business and consumer confidence, increasing consumer spending, and recovering housing fundamentals will continue to fuel growth in the world’s second largest economy. Further, major headwinds that have plagued the financial market seem to have faded with substantial positive developments in the global economy. In particular, the Chinese economy is showing signs of stabilization while the Japanese and European central banks have ramped up more stimulus measures to revive their economies.
Given the improving fundamentals, the historic turn is widely expected but a collapse in oil prices, which is raising fears of deflation, is weighing heavily on the Fed action. That being said, several ETFs are in focus on the upcoming Fed decision. A few ETFs will be rewarded if the Fed raises rates or signals a hawkish outlook while a few will be severely impacted. Let’s have a look to those:
ETFs to Gain
SPDR S&P Regional Banking ETF (KRE)
A rising interest rate scenario would be highly profitable for the financial sector as a whole. This is because the steepening yield curve would bolster profits for banks, insurance companies and discount brokerage firms. In particular, the ultra-popular KRE, having AUM of $2.7 billion and average daily volume of 4.7 million shares, will benefit the most (read: Buy Regional Bank ETFs Ahead of Fed Rate Hike).
The product follows the S&P Regional Banks Select Industry Index, charging investors 35 basis points a year in fees. Holding 93 securities in its basket, the fund is widely spread out across each security with an equal-weigh approach of around 1%. The product has a Zacks ETF Rank of 2 or ‘Buy’ rating with a High risk outlook.
PowerShares DB US Dollar Bullish Fund (UUP)
Rising interest rates will pull in more capital into the country and lead to appreciation of the U.S. dollar. UUP is the prime beneficiary of a rising dollar as it offers exposure against a basket of six world currencies – euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. This is done by tracking the Deutsche Bank Long US Dollar Index Futures Index Excess Return plus the interest income from the fund’s holdings of U.S. Treasury securities.
In terms of holdings, UUP allocates nearly 57.6% in euro while 25.5% collectively in Japanese yen and British pound. The fund has so far managed an asset base of $1.2 billion while sees an average daily volume of around 2.1 million shares. It charges 80 bps in total fees and expenses, and has a Zacks ETF Rank of 3 or ‘Hold’ rating with a Medium risk outlook.
Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF)
The diverging policy in the U.S. and the rest of the world will definitely compel investors to recycle their portfolio into the currency hedged ETFs. For those seeking exposure to the developed market with no currency risk, DBEF could be an intriguing pick. The fund follows the MSCI EAFE US Dollar Hedged Index and holds 931 securities in its basket, with none accounting for more than 1.92% share (read: 11 Most Popular Currency Hedged ETFs).
The product is skewed toward the financial sector with one-fourth of the portfolio, while consumer discretionary, industrials, consumer staples and health care round off the top five with double-digit exposure each. Among countries, Japan takes the top spot at 24%, closely followed by United Kingdom (18%), Switzerland (10%) and France (10%). The ETF has AUM of $13.0 billion and trades in solid volume of more than 4.1 million shares a day. It charges 35 bps in fees per year from investors and has a Zacks ETF Rank of 3 with a Medium risk outlook.
iPath US Treasury Steepener ETN (STPP)
As yield rises, bonds and the related ETFs fall. But this product directly capitalizes on rising interest rates and performs better when the yield curve is rising. The ETN looks to follow the Barclays US Treasury 2Y/10Y Yield Curve Index, which delivers returns from the steepening of the yield curve through a notional rolling investment in U.S. Treasury note futures contracts. The fund takes a weighted long position in 2-year Treasury futures contracts and a weighted short position in 10-year Treasury futures contracts. STPP charges 0.75% in fees and expenses while volume is light at around 1,000 shares a day. Additionally, it is an unpopular bond ETF with AUM of just $2.6 million.
ETFs to Lose
SPDR Gold Trust ETF (GLD)
Gold will continue to remain under immense pressure as higher interest rates would diminish gold’s attractiveness since the yellow metal does not pay interest like fixed-income assets and the product tracking this bullion like GLD will lose further. The fund tracks the price of gold bullion measured in U.S. dollars, and kept in London under the custody of HSBC Bank USA. It is the ultra-popular gold ETF with AUM of $21.6 billion and average daily volume of around 6.1 million shares a day. Expense ratio came in at 0.40%. The fund has a Zacks ETF Rank of 3 with a Medium risk outlook (read: Gold ETF (GLD) Hits 52-Week Low).
iShares FTSE NAREIT Mortgage Plus Capped Index Fund (REM)
Mortgage REITs could be in more trouble if the Fed starts raising rates as short-term rates would rise faster than the long-term rates thereby leading to a tight spread and lower profits for mREIT companies. REM is the most popular mortgage REIT ETF with AUM of $819.2 million and average daily volume of less than 1 million shares. The ETF tracks the FTSE NAREIT All Mortgage Capped Index and holds 38 securities in its basket with large allocations to the top two firms – Annaly Capital (NLY) and American Capital Agency (AGNC). These firms collectively make up for 26.4% share while other securities hold no more than 8.5% share. The fund charges investors 48 bps a year in fees and has a Zacks ETF Rank of 3 with a Medium risk outlook.
iShares iBoxx $ High Yield Corporate Bond ETF (HYG)
The high yield corner of the fixed income world is the most watched area ahead of the Fed meeting. This is because the exit from the rock-bottom interest rate policy would raise yields on the Treasury notes, thereby fading the sole lure of the high-yield bonds. HYG is the largest and most liquid fund in in the high yield bond space with AUM of over $14.4 billion and average daily volume of around 9 million shares. It charges 50 bps in fees per year from investors. The fund tracks the iBoxx $ Liquid High Yield Index and holds 1,009 securities in the basket. Effective duration and average maturity came in at 4.340 and 5.44 years, respectively. The ETF has a Zacks ETF Rank of 4 or ‘Sell’ rating with a High risk outlook (see: all the High Yield Bond ETFs here)
iShares MSCI Emerging Markets ETF (EEM)
The end of a cheap and an abundant dollar era would pull out more capital from the emerging markets, stirring up concern for most nations. Additionally, a prolonged weakness in commodities has been dampening the appeal for these markets. The most popular emerging market ETF – EEM – tracks the MSCI Emerging Markets Index and charges 68 bps in annual fees from investors (read: Emerging Market Crisis: 5 ETFs Down Over 30% in 2015).
Holding 846 securities, the product is widely spread out across various securities with none holding more than 3.51% of assets but is tilted toward the financial sector at 27.5%, followed by information technology (21.2%). Among the emerging countries, China takes the top spot at 26.3% while South Korea and Taiwan round off the next two spots with double-digit exposure each. The fund has a Zacks ETF Rank of 3 with a Medium risk outlook.
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