ETFs In Focus On Rate Hike Hopes Following Fed Minutes

The possibility of a rate hike increased following the release of the minutes from the U.S. Federal Reserve’s November meeting. In fact, data from CME Group (NASDAQ:CME) show a 93.5% chance of a rate increase in the December policy meeting. The chances of the first interest-rate increase in the year are high, considering that inflation has accelerated in the recent months and job market data is encouraging (read: U.S. Job Growth Momentum Continues: ETFs to Buy).

The minutes were largely in line with what Fed Chair Janet Yellen had said last week at Congress’s Joint Economic Committee. She said that an increase in interest rates could come “relatively soon”. When Fed officials met in November, a week before the U.S. election, they decided to maintain rates steady due to the relatively limited amount of information available since the September meeting and preferred to wait for more clarity on where inflation and employment were headed.

Last December, the Fed raised its benchmark interest rate from near zero to a 0.25% to 0.50% range and hinted at four hikes in 2016. However, the hikes didn’t come through owing to recurrent worries related to growth, downbeat employment data, weak inflation and volatility in the overseas market (read: ETFs to Watch as Fed Members Indicate Rate Hike in September).

Apart from the fact that the above mentioned issues have improved recently, Donald Trump’s win has also boosted optimism in the country. The U.S. president-elect plans to increase fiscal stimulus, which is likely to push long-term interest rates higher. Bank of America Merrill Lynch (NYSE:BAC) estimates that 10-year Treasuries will yield 2.65% percent by the end of 2017, about 34 basis points higher than the current level of 2.36% (recorded on November 23, 2016).

Market Impact

Since a rate hike is already priced in the market, U.S. stocks showed little reaction to the minutes release. The dollar modestly extended its gains against the euro. The bond market has already raised rates as it factored in inflationary expectations post Trump’s win. The crucial question that investors will look for an answer to in the December meeting is the number of rate hikes anticipated by the Fed in 2017.

ETFs in Focus

Winners

The financial sector will benefit from the rate hike. Meanwhile, the regulatory burden that had plagued the financial industry for quite some time is likely to ease under President-elect Trump’s administration. SPDR S&P Regional Banking ETF (CO:KRE) is up a significant 12.7% in the last 10 days. Higher interest rates will also result in the pouring of capital in the country and lead to appreciation of the U.S. dollar. As such, U.S. dollar ETF PowerShares DB US Dollar Bullish ETF (NYSE:UUP) UUP is up 3.1% in the last 10 days (read: ETF Winners & Losers as Dollar Hits 13-Year High).

Losers

Both utility and real estate sectors are rate-sensitive and perform well in a low rate environment. These require significant amount of debt to finance their investments and will be affected by the speculated hike. A popular utility ETF - Utilities Select Sector SPDR ETF XLU lost 1.8%, while broader real estate ETF – Real Estate Select Sector SPDR XLRE registered a loss of 0.2% in the past 10 days. The safe-haven precious metal gold also lost its shine with an improvement in market conditions. Gold bullion ETF SPDR Gold Shares (NYSE:GLD) (V:GLD) also fell about 6.8% in the past 10 days.

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