Back to top

Image: Bigstock

Yellen Hints at Faster Rate Hikes: 4 ETFs to the Rescue

Read MoreHide Full Article

Most recently, the Fed chair Janet Yellen commented that the U.S. rates may rise faster this year. She clarified that the economy should not turn into a bubble, thanks to a prolonged easy money era or run into a recession on a sudden rise in rates.

She also put stress on the almost-maximum employment and improving inflation which should allow the Fed to hike rates gradually and steadily. Investors should note that Yellen’s hawkish comments took the yield on 10-year U.S. Treasury note to 2.47% on January 19, 2017, from 2.33% on January 17 (read: 7 ETF Areas to Hog the Limelight in 2017).

Investors should note that the Fed raised the benchmark interest rates by a modest 25 bps) to 0.50–0.75% in December – the second after almost a decade on U.S. economic growth and strength in the labor market.

The Fed also predicts three rate hikes in 2017, up from the two guided in September. However, the projection of three hikes each in 2018 and 2019 remains unchanged. Yellen indicated that the future movement of the monetary policy largely depends on how the new government’s fiscal policy shapes up (read: Sole Fed Hike of 2016 Put These ETFs in Focus).

Yellen indicated that though wage growth has picked up pace, the scenario remains somber. Also, economic expansion “seems unlikely to pick up markedly in the near term”, thanks to soft foreign demand and possibilities of a gradual rise in rates.

Meanwhile, Yellen’s comments and uncertainty associated with the implementation of Trump’s policies kept the movement of stocks in check of late. Indeed, the prospects of a rate hike appear to be quite unsettling for investors, leading to losses for many bond investors.

A gradual decrease in cheap dollar inflows, blows to rate-sensitive sectors, declining demand for dividend stocks and ETFs may have spooked investors. However, there are ways to profit despite the bleak prospects. Below we highlight a few ways:

Inverse Bonds

Barclays Inverse US Treasury Aggregate ETN TAPR

The product looks to track the sum of the returns of periodically rebalanced short positions in equal face values of each of the Treasury Futures contract. It charges 43 bps in fees (read: 9 Winning ETF Ways for Those Who Fear Rising Yields).

Negative Duration Bonds

WisdomTree Barclays Negative Duration US Aggregate Bond ETF

As rates rise, bond prices fall which results in capital losses for those who do not hold bonds until maturity. Since bond duration measures the interest rate sensitivity, negative duration bond ETFs like AGND would be great tools in a rising rate environment.

Floating Rate Bonds

iShares Floating Rate Bond ETF FLOT

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 0.12 years and thus presents minimal interest rate risks (see all Investment Grade Corporate Bond ETFs here).

Senior Loans

Highland/iBoxx Senior Loan ETF SNLN

Senior loans are issued by companies with below investment grade credit ratings. In order to make up for this high risk, senior loans normally have higher yields. Since these securities are senior to other forms of debt or equity, these give protection to investors in any event of liquidation. As a result, default risk is low for such bonds, even after belonging to the junk bond space.

Moreover, senior loans are floating rate instruments and provide protection from rising interest rates. In a nutshell, a relatively high-yield opportunity coupled with protection from the looming rise in interest rates should help the fund perform better in the first half of 2017. SNLN could thus be a good pick for upcoming days. It yields around 4.77% annually.

Want key ETF info delivered straight to your inbox?

Zacks’ free Fund Newsletter will brief you on top news and analysis, as well as top-performing ETFs, each week. Get it free >>

Published in