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Fed Rate Hike to Bring These ETF Areas to the Forefront

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Wall Street is reeling under the pressure created by the Russia and Ukraine crisis. The Dow Jones Industrial Average is already down 2.9% so far this week. The S&P 500 and the Nasdaq Composite indices have also lost 3.7% and 3.9%, respectively, in the same time period.

Commenting on the current market conditions, Chris Senyek, Wolfe Research chief investment strategist, has mentioned that “The Russia/Ukraine conflict, commodity price spikes, inflation concerns, and a very uncertain Fed outlook
have caused recession fears to rapidly intensify and equity markets to sell off sharply,” per a CNBC article.

Going on, Fed Chairman Jerome Powell has already proposed a quarter-point hike in March to the Senate Banking Committee to control the red-hot inflation levels. Notably, Powell has mentioned about chances of resorting to taking more aggressive and tough actions if the high inflation levels prevail. The rate may be hiked at the Mar 15-16 monetary policy committee meeting.

Against this backdrop, let’s take a look at some ETF areas that might look attractive and gain investor attention:

Banking ETFs

The Federal Reserve has already started tapering bond purchases, which it expects to complete by March this year. The shift toward a tighter monetary policy will push yields higher, thereby helping the financial sector. This is because rising rates will help in boosting profits for banks, insurance companies, discount brokerage firms and asset managers. The steepening of the yield curve (the difference between short and long-term interest rates) is likely to support banks’ net interest margins. As a result, net interest income, which constitutes a chunk of banks’ revenues, is likely to receive support from the steepening of the yield curve and a modest rise in loan demand. Notably, as the economy starts operating in full swing, the banking space will be able to generate more business.

Let’s take a look at some banking ETFs that can gain from the current environment: First Trust Nasdaq Bank ETF (FTXO - Free Report) , Invesco KBW Bank ETF (KBWB - Free Report) , Invesco KBW Regional Banking ETF (KBWR), iShares U.S. Regional Banks ETF (IAT) and SPDR S&P Regional Banking ETF (KRE) (read: Warren Buffett Wins in 2022: ETF Lessons to Learn From).

Insurance ETFs

The insurance industry makes up a considerable size of the financial sector. A reduction in bond buying can push bond prices down. This may increase the yield to maturity of bonds. Higher bond yields might raise the market's risk-free returns. A risk-free market interest rate hike can raise the cost of funds, enabling financial companies to widen the spread between longer-term assets, such as loans, with shorter-term liabilities, thus boosting the financial sector’s profits margin.

Insurance providers are generally compelled to hold several long-term safe bonds to back the policies written. A higher interest rate will benefit insurance companies. The spread between the longer-term assets and shorter-term liabilities will increase the spread of insurers. Moreover, the insurance industry's profitability has risen historically during the period of rising interest rates. SPDR S&P Insurance ETF (KIE - Free Report) and iShares U.S. Insurance ETF (IAK - Free Report) are good options for investors to consider (read: Insurance ETFs to Rally on Solid Q4 Earnings).

Floating Rate ETFs

Floating rate bonds are basically investment grade in nature and are not supposed to pay a fixed rate to investors. Instead, they have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread and are determined based on the credit risk of the issuers.

Since the coupons of these bonds are adjusted periodically, these are less sensitive to rising rates compared to traditional bonds. Unlike fixed coupon bonds, these do not lose value when the rates go up, making the bonds ideal for protecting investors against capital erosion in a rising rate environment

Amid the current war scenario, the high chances of the Federal Reserve hiking the benchmark interest rates have raised the appeal of floating rate bonds. Since the coupons of these bonds are adjusted periodically, they are less sensitive to an increase in rates compared with traditional bonds. Against this backdrop, investors can consider ETFs like iShares Treasury Floating Rate Bond ETF (TFLO - Free Report) , iShares Floating Rate Bond ETF (FLOT - Free Report) and VanEck Investment Grade Floating Rate ETF (FLTR).

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