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Europe ETFs Likely to Gain From Low Rates After Draghi's Tenure

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The Euro zone indicated on Jul 25 that it could resort to new stimulus measures to boost its ailing economy as soon as in the September meeting. However, on Oct 31, Mario Draghi will step down as the ECB chief. Will this mean continuation of the easy money policy in the post-Draghi era?

Policies to Remain Loose

Nick Kounis, head of financial markets research at ABN AMRO, expects the ECB to slash all its policy rates by 10 bps at the September meeting, followed by another 10 bps step at the December meeting. However, economists — according to the Bloomberg Poll — see a 10 bps cut in the deposit rate in September, but “no change in December.”

The ECB’s likely next chief Christine Lagarde also hinted that she would stick to Mario Draghi’s expansionary monetary policy. On Aug 30, Lagarde noted that the European Central Bank (ECB) still has room to slash interest rates should the need be, although this may cause a financial stability risk.

However, many ECB policymakers do not see any need for a package that includes the resumption of bond buying. But banks like Goldman Sachs, Nomura and ABN Amro foresee a new round of QE. Societe Generale sees the ECB cutting the deposit rate by 20 basis points to minus 0.6% and announcing that it’ll start buying 40 billion euros ($44 billion) a month of debt, per Bloomberg (read: ECB May Cut Rates in September: ETFs in Focus).

While monetary stimulus is great for stocks, one of the biggest losers will be the euro. Talks of more monetary stimulus can cause Invesco CurrencyShares Euro Currency Trust (FXE - Free Report) to tumble.

Also, investors should be vigilant about the performance of the financial stocks. These stocks normally underperform in a low-rate environment. Though more stimulus means more activities in the economy and more dependence on financial institutions, low rates may compress banks’ net interest margin. This is why iShares MSCI Europe Financials ETF (EUFN - Free Report) may suffer. Investors should note that EUFN lost about 33.2% in the past five years against a 45.8% surge in the S&P 500.

Against this backdrop, below we highlight a few likely ETF winners, if the bank loosens monetary policy further.

Winners

International Treasury

On cues of more stimulus, the entire German bund curve yielded less than zero at August-end. Since yields and bond prices are inversely related, this fund iShares International Treasury Bond ETF (IGOV - Free Report) (which has a sizable exposure to Europe), may gain if the ECB cuts rates further.

Currency-Hedged Large-Cap Stocks

The continuation of the low-rate policy and a weaker Euro should boost the currency-hedged Euro zone ETFs in the near term. iShares Currency Hedged MSCI Eurozone ETF (HEZU - Free Report) and Xtrackers MSCI Eurozone Hedged Equity ETF (DBEZ - Free Report) could thus be gainers.

Dividend

Amid low rates, demand for high-yielding products should grow. So, investors can bet on ETFs like WisdomTree Europe SmallCap Dividend Fund (DFE - Free Report) , which yields about 4.23% annually (read: 5 Dividend ETFs to Play to Follow Goldman Sachs (Revised)).

Small Cap

Low interest rates and stimulus may help the domestic-focused, small-cap ETFs to some extent. WisdomTree Europe Hedged SmallCap Equity Fund (EUSC - Free Report) can thus benefit.

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