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ETFs to Win or Lose on Hawkish Fed Minutes (Revised)

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The latest Fed minutes came across as hawkish and revealed policymakers’ concern about worsening inflation. The members said that the jobs market is nearing full employment. The probabilities of a March interest rate hike of 0.25% surged to 72%, according to fed futures trading contracts. If enacted, this will mark the Fed’s first rate hike in three years to counter inflation.

The U.S. central bank has already paced up QE tapering. The central bank plans to buy $60 billion per month of bonds in combined Treasuries and agency mortgage-backed securities starting in January, down from $90 billion in December and 120 billion from the start of the pandemic through November. Plus, the bank upped its economic growth projections, raised its inflation outlook and cut unemployment rate projections.

While officials did not make any plans about when the Fed will start rolling off the nearly $8.3 trillion in Treasuries and mortgage-backed securities it is holding, statements out of the meeting indicated that the process could begin in 2022, per a CNBC article.

“Almost all participants agreed that it would likely be appropriate to initiate balance sheet runoff at some point after the first increase in the target range for the federal funds rate,” the meeting summary highlighted. With the possibility of a hawkish Fed in 2022, stocks started falling and government bond yields started rising.

Below we have highlighted a few ETF winners and losers.

ETFs to Gain

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

Banks are beneficiaries of rising rates. As banks seek to borrow money at short-term rates and lend at long-term rates, a steepening yield curve earns more on lending and pays less on deposits, thereby leading to a wider spread. This expands net margins and increases banks’ profits (read: 7 ETF Predictions for 2022).

iShares Floating Rate Bond ETF (FLOT - Free Report)

The underlying Bloomberg US Floating Rate Note < 5 Years Index comprises U.S. dollar-denominated, investment-grade floating rate bonds with remaining maturities between one month and five years. The fund charges 15 bps in fees.

ProShares High Yield Interest Rate Hedged (HYHG - Free Report)

The underlying FTSE High Yield (Treasury Rate-Hedged) Index comprises long positions in USD-denominated high yield corporate bonds and short positions in U.S. Treasury notes or bonds of approximate equivalent duration. Such a technique of interest-rate hedging makes the fund well-positioned to play in a rising rate environment. The fund charges 51 bps in fees and yields 4.54% annually.

Invesco S&P MidCap 400 Pure Value ETF (RFV - Free Report)

Value funds normally fare better in a rising-rate environment. Investors should note that value stocks underperform growth stocks in a low-rate environment. With the yield on 10-year Treasuries making an uptrend, there could be a shift from momentum to value shares.

iShares Russell 2000 ETF (IWM - Free Report)

Rising rates add strength to the U.S. dollar. This is going to favor small-cap stocks, which are more domestically exposed. Since these companies do not have much exposure to the international markets, a higher greenback does not bother their profitability.

ETFs to Lose

Invesco QQQ (QQQ - Free Report)

Nasdaq posted its biggest daily drop since February after the “hawkish” Fed minutes on Jan 5. Since QQQ is tech-heavy and high-growth in nature, the underlying index Nasdaq-100 tends to underperform in a rising rate environment. Rising interest rates will weigh on stock multiples, especially for technology and other growth stocks.

ProShares Bitcoin Strategy ETF (BITO - Free Report)

Bitcoin and other cryptocurrencies slumped as global stocks came under pressure on hawkish Fed minutes. Plus, the SEC delayed the decision on NYDIG’s spot Bitcoin ETF proposal. A rising rate environment is not beneficial for a super-speculative asset like bitcoin.

Vanguard MortgageBacked Securities ETF (VMBS - Free Report)

The rate on the 30-year fixed mortgage — the most common home loan for homebuyers — rose from 3.11% to 3.22% this week, the highest level since May 2020, according to Freddie Mac, quoted on Yahoo. The rate is more than half-point higher than 2.65% from a year ago. No wonder, VMBS will likely underperform in the coming days.

iShares U.S. Home Construction ETF (ITB - Free Report)

Homebuilding stocks and ETFs may take a hit in the coming days due to the double whammy of rising home prices and higher mortgage rates. Though valuations are still cheaper for housing ETFs like ITB, the path ahead is full of hurdles.

Utilities Select Sector SPDR ETF (XLU - Free Report)

This is yet another rate-sensitive sector. Utilities are reliant on debt, which will now become pricier. Plus, the demand for yield in the utilities sector will come down now as safe-haven treasuries are also yielding handsomely.

(We are reissuing this article to correct a mistake. The original article, issued on January 07, 2022, should no longer be relied upon.)