The latest Fed minutes signaled chances of a faster hike in rates in the United States this year. Rising inflationary expectations amid the materialization of tax cuts are driving such fears among investors. This has pushed the yield on 10-year U.S. Treasury bonds to a four-year high of 2.94%, up from 2.46% recorded at the start of the year (read: 7 Ways to Play Rising Yields With Inverse Treasury ETFs).
Yield on the 30-year Treasury bond shot up to its highest since July 2015, while yield on the two-year Treasury note scaled the highest level since September 2008. Some U.S. asset managers expect the Federal Reserve to raise U.S. overnight interest rates four times this year, more than the three penciled by Fed policymakers.
According to the CME's FedWatch tracking tool, traders have already baked in three rate hikes while there's a 30% probability of a fourth hike. As per a note released by Goldman Sachs Asset Management last week, yield on the U.S. 10-year note is likely to hit 3.5% within the next six months as monetary policy tightening continues.
Against this backdrop, we think the ETFs mentioned below might outperform in the days ahead if inflationary expectations and rising rate worries remain.
Sit Rising Rate ETF (RISE - Free Report)
The underlying benchmark portfolio index comprises exchange traded futures contracts and options on futures on 2, 5 and 10-year U.S. Treasury securities are weighted to achieve targeted negative 10-year average effective portfolio duration. The fund charges 50 bps in fees and has gained about 0.1% on Feb 21.
SPDR Portfolio Mid Cap ETF (SPMD - Free Report)
Given the rise in bond yields and the strengthening of the greenback, more domestically-focused stocks are likely to outperform as these have lower foreign exposure and will be hurt less by a stronger greenback.
While small-cap stocks could be used for such an exposure, mid-caps appear to be more apt as these have certain overseas focus and are poised to benefit from an improvement in foreign economies. Mid-cap securities with the middle-of-the path approach are also viewed as big and safe compared to the highly volatile small-cap exposure.
SPMD yields 3.27% annually and charges 5 bps in fees. The fund gained about 0.2% on Feb 21.
SPDR S&P Bank ETF (KBE - Free Report)
Financial stocks perform better in a rising rate environment. The underlying index of the fund — the S&P Banks Select Industry Index — is a modified equal-weighted index that looks to track the performance of publicly-traded companies that operate as banks or thrifts. The fund charges 35 bps in fees and has advanced about 0.8% on Feb 21 (read: 5 ETF Ways to Trade Surging Inflation).
PowerShares S&P Small-Cap Health Care Portfolio (PSCH - Free Report)
Health care stocks are seen as relatively defensive and can provide safety to one’s portfolio during market downturns. Healthcare Equipment & Suppliers and Providers & Services account for half of the portfolio. As per an article published on Reuters, domestically-geared healthcare companies that focus on services are poised to benefit from the lower tax rate.
Mizuho Securities analysts viewed tax reform as a significant positive cash flow event, especially for healthcare services companies that tend to have considerable capital expenditures. The fund gained about 1.9% on Feb 21.
ProShares Inflation Expectations ETF (RINF - Free Report)
Higher inflationary expectations make it necessary to focus on an inflation-oriented fund. The underlying index — the Citi 30-Year TIPS (Treasury Rate-Hedged) Index — tracks the performance of long positions in the most recently issued 30-year TIPS and duration-adjusted short positions in U.S. Treasury bonds of, in aggregate, approximate equivalent duration dollars to the TIPS. It yields 2.89% annually and charges 30 bps in fees.
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