As widely expected, the Fed effected the fourth-rate hike in a decade in its June meeting. The Fed raised the benchmark interest rates by a modest 25 bps to 1–1.25%, confirming the U.S. economy’s growth momentum and the labor market’s well-being. This was the Fed’s second hike this year. The Fed also reinforced its plans for normalizing its $4.2-trillion balance sheet as soon as this year and gradually speeding up the process.
The Fed announced three rounds of “quantitative easing" or QE from 2008 through 2012, buying mostly long-term Treasuries and mortgage backed securities and beefing up its portfolio. The move was aimed at goading economic activity. Now, the Fed is planning to end reinvestment of the proceeds from these bonds (read: ETF Strategies to Win if Fed's Reverse QE Hits Soon).
The initial target of lessening of the Fed's Treasury holdings would be fixed at $6 billion per month, “increasing by $6 billion increments every three months over a 12-month period until it reached $30 billion per month.” For agency debt and mortgage-backed securities, the cap will be $4 billion per month at first, and rise by $4 billion every quarter over a year till it touches $20 billion per month.
Normally, investors expect such moves to hit rate-sensitive and dividend-paying sectors like utility and real estate but push up bond yields and financial ETFs – a rising rate beneficiary. But in reality, just the opposite has happened. Yields of the benchmark 10-year U.S. Treasury dropped 6 bps to 2.15% on June 14, 2017 from the day before and the greenback nosedived too.
Why Such Market Behavior?
First of all, this June hike was too obvious to leave an impact on the broader investing world. So, the Fed activity sent no shockwave as the impact was already baked in the asset classes. Now, with Fed officials sticking to their outlook for one more rate hike this year, there is no spark in the guidance either. The median Fed’s funds rate for this year was unchanged at 1.4%.
The Fed has forecast U.S. economic growth of 2.2% for 2017, up 10 bps from the March projection. However, inflation guidance was cut to 1.7% by the end of this year, from 1.9% guided in March.
Along with the inflation concern, a report that a probe against President Donald Trump to see if he tried to manipulate justice and a steep slump in crude oil prices kept investors edgy.Plus, retail sales dropped 0.3% in May, the most since January 2016.
A still-subdued inflation, upheaval in the oil patch and political uncertainty eased heightened fears of faster policy tightening. The key U.S. equity gauge, the S&P 500-base ETF SPDR S&P 500 ETF Trust (SPY - Free Report) , fell over 0.1% on June 14, 2017. Bond yields thus fell, making space for a fixed-income rally at least for the near term.
Surprise ETF Winners
Long-Term U.S. Treasury Bonds
Long-term bond ETF Vanguard Extended Duration Treasury ETF (EDV - Free Report) added over 2.2% post Fed comments on June 14, 2017.
With strengthening corporate America and dovish Fed rate outlook, there were all reasons for funds like WisdomTree Strategic Corporate Bond Fund andLong-Term Corp Bond ETF SPDR (LWC - Free Report) tosee a spike. The duo added about 2% and 1.2% on June 14, 2017, respectively. The fund yields 3.47% and 4.15% annually (read: Dividend ETFs Are Hot on Likely Dovish Fed Outlook).
Needless to say, sectors that perform well in a low interest rate environment and offer higher yield, gained on June 14. Since housing and safe sector utility are rate-sensitive, SPDR S&P Homebuilders ETF (XHB - Free Report) and Vanguard Utilities ETF (VPU - Free Report) added about 0.7% and 0.6%, respectively, on June 14, 2017.
Multi-asset ETFs are great picks in times of uncertainty and have been doing well recently. For examples, iShares Morningstar Multi-Asset Income (IYLD - Free Report) added about 0.4% on June 14 and yields about 4.43% annually. This fund offers about 68% exposure to U.S. securities while international products occupy the rest. Among the asset classes, bond takes the top spot at nearly 50% while common equity (35%) and preferred equity (5%) hold the next two positions (read: Should You Diversify Your ETF Portfolio Amid Rising Uncertainty?).
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