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Rate-Sensitive Sector ETFs to Go Short on As Fed Turns Hawkish

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Fed Chair Jerome Powell turned hawkish during his testimony to the Senate Banking Committee. He also warned that U.S. interest rates might need to go up even faster and higher than expected to rein in stubborn inflation (read: PCE Inflation Jumps the Most Since June: 5 ETFs to Play).

This is expected to take a toll on the rate-sensitive, high-yield sectors such as utilities and real estate. When interest rates rise, these sectors, known for the income they generate, fall out of favor as investors gain similar levels of income without any stock risk.

In such a scenario, investors could make a short-term bearish play on the rate-sensitive sectors as they continue to trade sluggishly if interest rates keep rising. While futures or short-stock approaches are some possibilities, inverse ETFs like ProShares Short Real Estate ETF (REK - Free Report) , ProShares UltraShort Real Estate ETF (SRS - Free Report) , Direxion Daily Real Estate Bear 3X Shares (DRV - Free Report) and ProShares UltraShort Utilities ETF (SDP - Free Report) might be good options.

Inverse ETFs provide opposite exposure that is a multiple (-1, -2 or -3 times) of the performance of the underlying sector using various investment strategies, such as swaps, futures contracts and other derivative instruments.

Since most of these funds seek to attain their goal on a daily basis, their performance could vary significantly from the inverse performance of the underlying index or benchmark, over a longer period when compared to a shorter period (weeks, months or years) due to the compounding effect.

However, these funds are cheaper than direct shorting or utilization of futures contracts. Given this, investors seeking to capitalize on the rising rate scenario in a short span could consider any of the following ETFs, given the bearish outlook for the sectors. Investors should note that each of the products charges 95 bps in annual fees from investors. 

Hawkish Fed

Federal Reserve Chair Jerome Powell told the Senate Banking Committee that the central bank will likely raise its key interest rate higher than anticipated and could resume larger hikes, citing a recent surge in job growth and inflation, after slowing the pace in recent months.

According to the CME FedWatch Tool, market expectations for a half-point rate hike spiked, shifting from a 30% probability to almost 70% by the day's end. Treasury yields soared with 2-year yields reaching their highest level since 2007. The 2-year yields fell below that of the 10-year, indicating a recession (read: Inverse Treasury ETFs Soar as Yields See Big Monthly Gain).

Goldman Sachs raised its forecast for peak Federal Reserve rates to 5.5-5.75% following the hawkish testimony by Jerome Powell that opened the door to a half percentage-point increase later this month.

ProShares Short Real Estate ETF (REK - Free Report)

ProShares Short Real Estate ETF seeks to deliver the inverse return of the daily performance of the Dow Jones U.S. Real Estate Index. The ETF makes profits when real estate stocks decline and is suitable for hedging purposes against the fall of these stocks. ProShares Short Real Estate ETF has amassed $38.9 million in its asset base while volume is moderate at around 785,000 shares a day.

ProShares UltraShort Real Estate ETF (SRS - Free Report)

ProShares UltraShort Real Estate ETF offers two times inverse exposure to the performance of the Dow Jones U.S. Real Estate Index. It has managed assets worth $57 million and charges 95 bps in fees per year. ProShares UltraShort Real Estate ETF trades in an average daily volume of 124,000 shares.

Direxion Daily Real Estate Bear 3X Shares (DRV - Free Report)

Direxion Daily Real Estate Bear 3X Shares seeks to deliver three times the inverse performance of the Real Estate Select Sector Index. It has AUM of $178.2 million and an average daily volume of around 537,000 shares.

ProShares UltraShort Utilities ETF (SDP - Free Report)

ProShares UltraShort Utilities ETF seeks to deliver twice (2X or 200%) the inverse return of the daily performance of the Dow Jones U.S. Utilities Index. It has $2.7 million in AUM and an average trading volume of nearly 21,000 shares per day.

Bottom Line

Investors should note that these products are suitable only for short-term traders as these are rebalanced on a daily basis (read: all Inverse Equity ETFs here).

Still, for ETF investors who are bearish on the securities of the high-yielding sectors in the near term, any of the above products could make an interesting choice. Clearly, a near-term short could be intriguing for those with a high-risk tolerance and a belief that the “trend is the friend” in this corner of the investing world.

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