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Fed Bumps Up Economic Growth Forecasts: ETFs to Play

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As widely expected, the Fed held interest rates steady at a near-zero level in its latest meeting. U.S. interest rates have been this low since March 2020. Federal Reserve officials continued to project near-zero interest rates at least through 2023, while boosting economic growth expectations on vaccine and stimulus optimism.

Inside the Upbeat Economic Forecast

The Fed upgraded its forecast for 2021 GDP growth from 4.2% in December to 6.5% and beefed up the 2022 growth forecast from 3.2% to 3.3%. However, growth is likely to slow down in 2023 to 2.4% from 2.2%. The Fed projected the longer-run growth measure at 1.8%.

Unemployment was guided down to 4.5% from 5.0% for 2021, 3.9% from 4.2% for 2022 and 3.5% from 3.7% for 2023. PCE inflation expectation has gone up to 2.4% for 2021 from 1.8% projected in December, to 2.0% for 2022 (from 1.9%) and 2.1% for 2023 (from 2.0%). Median Federal funds rate projection for the long term was kept unchanged at 2.0%.

Market Reaction

The immediate impact should be felt in the bond market. The yield on 10-year U.S. Treasury remained slightly higher on Mar 19, 2021 from the prior day at 1.63%. The 10-year Treasury yield, notably started 2021 under 1%. Some market watchers, notably BlackRock’s Rick Rieder, believe the yield could hit 2% this year, as quoted on CNBC (read: ETFs to Win/Lose If U.S. 10-Year Yield Shoots Up to 2%).

Against this backdrop, investors can bet on the following ETFs for current income and likely capital appreciation.

Value – SPDR Portfolio S&P 500 Value ETF (SPYV - Free Report)

With U.S. economic growth projections witnessing uptrend, yields are likely to see modest but steady uptrend. Rising rates are good for value stocks than growth ones as the latter’s cash flows come way out in the future.Thus this group seems less valuable in a rising rate scenario as indicated by New York University finance professor Aswath Damodaran, as quoted on CNBC. So, it’s better to go for mature value stocks (read: 4 Sectors & Their ETFs Offering Great Value Now).

Convertible Bonds – SPDR Bloomberg Barclays Convertible Securities ETF (CWB - Free Report)

Convertible bonds are those that can be exchanged if the holder chooses to, for a specific number of preferred or common shares if the company's share price climbs past a said conversion price during the bond's tenure. The underlying Bloomberg Barclays US Convertible Liquid Bond Index is designed to represent the market of U.S. convertible securities. The fund yields 2.24% annually and charges 40 bps in fees (read: Convertible Bond ETFs: A Pandemic Winner).

Corporate Bonds – PIMCO Investment Grade Corporate Bond Index ETF (CORP - Free Report)

If you really want a fixed-income exposure, investment-grade corporate bonds are great now. The underlying ICE BofAML US Corporate Index is an unmanaged index comprising U.S. dollar denominated investment-grade, fixed-rate corporate debt securities publicly issued in the U.S. domestic market with at least one-year remaining term to final maturity and at least$250 million outstanding. These bonds are highly rated. The fund yields 2.98% annually and charges 20 bps in fees.

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).

Small-Caps – iShares Russell 2000 ETF (IWM - Free Report)

Investors should note that small-cap stocks are likely to do better in a growing economy since these are tied more to domestic activities. So, with the GDP growth forecast being upgraded, investors have every reason to play the small-cap ETF IWM.

Financials – SPDR S&P Bank ETF (KBE - Free Report)

If the yield curve steepens ahead, banking stocks may gain. Moreover, an improving economy is always great for banking stocks as these give cues of corporations’ and households’ better financial health. This, in turn, results in lower delinquency rate.

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