September Rate Hike Odds High: Bet on These ETFs

The latest Fed minutes signal at a faster hike in rates in the United States as long as the economy is healthy. The Fed has enacted two rate hikes so far this year and is widely expected to tighten the policy again in September. Rising inflationary expectations amid steady U.S. economic growth and trade war fears led to the widespread speculation among market watchers.

As of now, federal funds futures showed a 96% probability of a quarter percentage point rate hike to 2.00-2.25% at its Sep 25-26 meeting, per CME Group’s FedWatch program. And there is a 66% chance of a rate hike to 2.25-2.50% in its Dec 18-19 meet.

Inside the Economic Well-being

The U.S. economy advanced at a 4.1% annual rate (the best clip in nearly four years) in Q2, higher than 2.2% expansion in the previous period and in line with market expectations (read: 5 ETFs to Buy as Q2 GDP Growth Hits 4-Year High of 4.1%).

The U.S. labor market is steady and retail sales have been pretty encouraging as well. U.S. labor costs recorded the largest annual rise since 2008 in the second quarter. U.S. annual inflation rate was 2.9% in July 2018 — the highest since February 2012. The tax reform is yet another boon for U.S. stocks. Corporate earnings have been in great shape as well.

Signs of Worry?

Simultaneously, officials noted that they might have to put policy tightening on hold if there is an escalation in the international trade tiff. Fed officials were united in their views that a trade war could derail the economic growth momentum.

Notably, starting Aug 23, an additional 25% of tariffs are going to be imposed on $16 billion worth of Chinese imports, prompting a Chinese reprisal on an equal value of American goods. This is probably why the yield on 10-year U.S. Treasury dropped by 3 bps to 2.82% on Aug 22 despite relatively hawkish Fed minutes.

Whatever be the case, along with several other analysts, we believe that a rate hike next month is almost certain, though the picture beyond that is obscure.

How to Profit From Fed’s Guidance?

Small-Cap

Investors should note that small-cap stocks are likely to do better in a rising rate environment since they are tied more to domestic activities and thus are unaffecred by a rising dollar environment (which is a possible outcome if interest rates rise). Also, with the release of upbeat GDP growth data, investors have all the more reasons to play small-cap ETFs likeInvesco Russell 2000 Pure Growth ETF PXSG. The fund gained about 0.2% on Aug 22 (read: Longest Bull Run for US Market: 5 Growth ETF Picks).

Consumer Discretionary

An improving economy with a strengthening labor market and a moderately rising interest rate environment is great for consumer discretionary stocks. First Trust Nasdaq Retail ETF FTXD, which was up 1.4% on Aug 22, can be thus on investors’ wish list (read: Time to Buy Consumer Discretionary ETFs: 5 Top Picks).

Private Equity ETFs

If bond yields start to rise on faster policy tightening, investors will need to focus on stable bets that offer way higher than the benchmark yield.  Private equity ETFs are known for this. Invesco Global Listed Private Equity ETF PSP, which yields about 9.69% annually, added 0.6% on Aug 22. Private equity has a low correlation to the broader market but might underperform severely in case of a global meltdown, which is not the case at present.

Convertible Bonds

Stock markets being more-or-less steady, the U.S. economy on solid grounds and monetary policy normalizing, convertible bonds should be back in the limelight. Convertible bonds offer investors the right to convert their bond holdings into a company’s shares at the holder’s discretion. iShares Convertible Bond ETF ICVT gained about 0.5% on Aug 22 (read: Why 2018 Could Be Great for Convertible Bond ETFs).

ProShares Inflation Expectations ETF RINF

Be it economic growth or trade war, all will lead to a higher inflation. Higher inflationary expectations make it necessary to focus on an inflation-oriented fund.  The underlying index — the Citi 30-Year TIPS (Treasury Rate-Hedged) Index — tracks the performance of long positions in the most recently issued 30-year TIPS and duration-adjusted short positions in U.S. Treasury bonds of, in aggregate, approximate equivalent duration dollars to the TIPS. It yields 2.98% annually and added more than 0.1% on Aug 22.

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FT-NDQ RETAIL (FTXD): ETF Research Reports
 
PWRSH-GLBL LIST (PSP): ETF Research Reports
 
PRO-SH INFL EXP (RINF): ETF Research Reports
 
ISHARS-CONV BD (ICVT): ETF Research Reports
 
PWRSH-F P SM GR (PXSG): ETF Research Reports
 
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