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Fed Rate Hike in the Cards? ETFs to Buy

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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. However, the forecast revealed that 13 members of the Federal Open Market Committee believe the Fed will hike rates in 2023 and the majority expect at least two hikes that year, per a CNBC article. Seven of the 18 members see the Fed increasing rates as early as 2022.

The Fed also hiked its inflation forecast for the year. The central bank now expects inflation to jump to 3.4% this year, higher than its previous forecast of 2.4%. PCE inflation expectation has gone up to 2.1% for 2022 from 2% projected in March and to 2.2% for 2022 (from 2.1%).

The Fed upgraded its forecast for 2021 GDP growth from 6.5% in March to 7.0% and beefed up the 2023 growth forecast from 2.2% to 2.4%. The Fed projected the longer-run growth measure at 1.8%.

Market Reaction

The immediate impact was felt in the bond market. The yield on 10-year U.S. Treasury rose on Jun 16, 2021 to 1.57% from the prior day at 1.51%. The 10-year Treasury yield, notably started 2021 under 1%.

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 an uptrend, yields are likely to see a modest but steady uptrend. Rising rates are good for value stocks than the 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 fund yields 2.76% annually and charges 20 bps in fees.

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 2.76% 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 (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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