ETF ranges poised to benefit from the Fed’s aggressive tone
Wall Street endured another dull trading session as the market felt pressure from an aggressive stance from the Fed on rising inflation levels. The Dow Jones Industrial Average fell 0.4% on April 6th. The other two broad market indices, the S&P 500 and the Nasdaq Composite, also lost 0.9% and 2.2%, respectively, on the same day.
The recently released FOMC March meeting minutes highlighted the central bank’s plans to control inflation levels through larger rate hikes. It also outlined the method and extent of the reduction in the balance sheet, which includes around $9 trillion in assets. Remarkably, Federal Reserve officials have decided to trim their balance sheet by about $95 billion a month. More specifically, the Fed plans to reduce $60 billion in Treasuries and $35 billion in mortgage-backed securities gradually over a three-month period, beginning in May (according to a CNBC article).
The minutes also noted that “many participants noted that — with inflation well above the committee’s target, inflation risks to the upside, and the Federal Funds Rate well below participants’ estimates for longer-term levels — they would have preferred a 50 basis point hike of the target range for the federal funds rate at this session,” reads a CNBC article.
Notably, on March 16, the Fed approved a 0.25 percentage point rate hike (the first hike since December 2018). After this increase, the key interest rates will be in a range of 0.25 to 0.5%. At the same time, the central bank announced plans to raise interest rates six times this year.
Soaring commodity prices due to the Russia-Ukraine war have increased Federal Reserve concerns. Russia and Ukraine occupy important positions as producers in the global commodity market. Hence, the escalation of tensions has triggered a rally in a broad range of commodities.
Recent developments may also slow down manufacturing activities and affect exports of raw materials and goods. This is true as tensions in an already tight commodity market have led to supply disruptions.
With that in mind, let’s take a look at some ETF ranges that look attractive and could catch investors’ attention:
The move to tighter monetary policy will boost yields, thereby helping the financial sector. Because rising interest rates will help boost profits for banks, insurance companies, discount brokerage firms and wealth managers. The steepening of the yield curve (the difference between short and long-term interest rates) should support banks’ net interest margins. As a result, net interest income, which accounts for a large part of banks’ income, should be supported by the steepening of the yield curve and a modest increase in credit demand. Especially when the economy is in full swing, the banking sector will be able to generate more business.
Let’s take a look at some bank ETFs that can benefit from the current environment: First Trust Nasdaq Bank ETF FTXO, Invesco KBW Bank ETF KBWB, Invesco KBW Regional Banking ETF (KBWR), iShares US Regional Banks ETF (IAT) and SPDR S&P Regional Banking ETF (KRE) (read: Warren Buffett wins in 2022: ETF lessons to learn from).
The insurance industry makes up a significant part of the financial sector. A reduction in bond purchases can push down bond prices. This can increase the yield to maturity of bonds. Higher bond yields could increase the market’s risk-free returns. A risk-free increase in market interest rates can increase funding costs, allowing financial firms to widen the spread between longer-term assets, such as loans, and shorter-term liabilities, thereby increasing the financial sector’s profit margin.
Insurance providers are generally forced to hold multiple long-term secure bonds to back the policies they take out. Insurance companies benefit from a higher interest rate. Spread between longer-term assets and shorter-term liabilities will increase insurers’ dispersion. In addition, the profitability of the insurance industry has historically increased during periods of rising interest rates. SPDR S&P Insurance ETF AI and iShares US Insurance ETF IAK are good options for investors to consider (read: Insurance ETFs rebound on solid Q4 earnings).
Floating Rate ETFs
Floating rate bonds are investment grade bonds and are not intended to pay investors a fixed rate of interest. Instead, they have variable coupon rates, often tied to an underlying index (such as LIBOR) plus a variable spread, determined based on issuers’ credit risk.
Because the coupons on these bonds are adjusted regularly, they are less sensitive to rising interest rates than traditional bonds. Unlike fixed income bonds, these do not lose value when interest rates rise, making them ideal for protecting investors from capital erosion in a rising interest rate environment.
Amid the current war scenario, the Federal Reserve’s aggressive stance on raising interest rates has increased the appeal of adjustable-rate bonds. Because the coupons on these bonds are adjusted regularly, they are less sensitive to interest rate increases than traditional bonds. With this in mind, investors are welcome to consider ETFs iShares Treasury Floating Rate Bond ETF TFLO, iShares Floating Rate Bond ETF FLOT and VanEck Investment Grade Floating Rate ETF (FLTR).
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Invesco KBW Bank ETF (KBWB) ETF Research Reports
iShares US Insurance ETF (IAK) ETF Research Reports
SPDR S&P Insurance ETF (KIE): ETF Research Reports
iShares Floating Rate Bond ETF (FLOT): ETF Research Reports
First Trust NASDAQ Bank ETF (FTXO): ETF Research Reports
iShares Treasury Floating Rate Bond ETF (TFLO): ETF Research Reports
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Zacks Investment Research
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.