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ETFs to Win/Lose If U.S. 10-Year Yield Shoots Up to 2%

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Rising rate is a key concern in the market right now. Growing vaccine distribution and the rollout of the $1.9 trillion fiscal stimulus under the Biden era have resulted in a sooner-than-expected recovery of the U.S. economy. These have stoked inflation concerns and pushed up treasury yields.  

The 10-year U.S. treasury yield rose to 1.53% as of Mar 10, 2021 versus 0.93% recorded at the start of the year.  The benchmark U.S. Treasury yield is likely to hit 2% by the end of the year but could shoot “well above” that in the second quarter, according to ING senior rates strategist Antoine Bouvet, as quoted on CNBC.

An ING strategist expected bigger inflation readings only to show up by the end of the second quarter of 2021, “potentially peaking around 3.5% and above.” Right now, the inflation pressure is still under control. True to his views, the core CPI in the month of February inched up 1.3% on a year-on-year basis, receding from January’s 1.4% gain.

However, overall consumerinflation rate in the United States increased to 1.7% in February of 2021 from 1.4% in January compared to market forecasts of 1.7%.  ING expects average inflation to reach 2.9% this year and remain at that level in 2022.

This puts the spotlight on some ETF areas that could win or lose in the medium term. Let’s have a look.

ETFs to Gain

SPDR S&P Bank ETF (KBE - Free Report)

With the Fed being dovish and risk-on sentiments boosting long-term yields, the yield curve will steepen further. The biggest winner of the steepening yield curve is the banking sector. Bargain hunting could also lead to some gains. As banks seek to borrow money at short-term rates and lend at long-term rates, a steepening yield curve will earn more on lending and pay less on deposits, thereby leading to a wider spread. This will expand net margins and increase banks’ profits.

iShares Floating Rate Bond ETF (FLOT - Free Report)

Floating rate notes are investment grade bonds that do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of issuers.

Since the coupons of these bonds are adjusted periodically, they are less sensitive to an increase in rates compared to traditional bonds. FLOT has an effective duration of 0.13 years and thus presents minimal interest rate risks (see all Investment Grade Corporate Bond ETFs here).

The WisdomTree Interest Rate Hedged U.S. Aggregate Bond Fund (AGZD - Free Report)

AGZD looks to combine a long position in cash bonds representative of AGG with a short position in Treasury Bonds and/or Treasury futures to target the zero-interest rate exposure. Such technique of interest-rate hedging makes the fund well positioned to play in a rising rate environment. It yields 2.18% annually (read: Play 4 Rate-Proof Bond ETFs in a Rising Rate Environment).

Industrial Select Sector SPDR ETF (XLI - Free Report)

Economic improvement, Biden’s bet on boosting infrastructure and a likely rebound in cyclical stocks augur well for industrial ETFs like XLI. Along with expected capital gains, the fund offers decent yields of about 1.46% annually at the current level (see all Industrials ETFs here).

iShares TIPS Bond ETF (TIP - Free Report)

TIPS could be an interesting bet when inflation gains steam. TIPS ETFs offer robust real returns during inflationary periods unlike its unprotected peers in the fixed-income world. These securities pay an interest on an inflated-principal amount (principal rises with inflation) and when the securities mature, investors get either the inflation-adjusted principal or the original principal, whichever is greater. As a result, both principal amount and interest payments will keep on increasing with rising consumer prices. The fund TIP yields 1.09% annually.

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