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3 ETFs to Better Prepare for Aggressive Rate Hikes

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U.S. markets saw a selloff in the first quarter on apprehensions of rate hikes and trade war fears. Although the Fed forecasts two more rate hikes in 2018 after the March one, latest data released by the Labor Department has made some economists believe that this year might have four hikes in store.

Into the Headlines

The year-over-year hike in consumer prices rose from 2.2% in February to 2.4% in March — the highest in a year. Moreover, core inflation, which excludes prices of volatile items such as food and oil, ticked up 2.1% in March from 1.8% in the preceding month. On a monthly basis, core CPI increased 0.2% while the overall CPI contracted 0.1%.

The strength in the core CPI figure goes to show that inflation numbers were initially weighed down by weakness in the mobile phone services category. Since the weakness has dissipated, economists expect the Fed to achieve its 2% inflation target with respect to PCE inflation earlier than expected. PCE inflation data is due for release on Apr 30 and will help provide a clearer picture with regard to Fed’s stance on rate hikes.  

Moreover, the U.S. economy has been exhibiting strong job trends. After a blockbuster February, with job gains of 326,000, the U.S. economy relatively cooled down and managed to register job gains of 103,000 in March.  However, job gains grew for the 90th consecutive month while unemployment remains at a record low of 4.1%.

U.S. producer prices also showed strong gains, with producer price index gaining 0.3% in March compared with 0.2% in the previous month. “With underlying producer price inflation already at a seven-year high and the tightening labor market set to put upward pressure on wage growth, we expect a continued rise in inflation to prompt Fed officials to raise rates four times in total this year,” per a CFO.com article citing economist Andrew Hunter of Capital Economics.

Geopolitics

Adding to the agony of investors praying for lower inflation, crude prices are on the rise. Following a chemical attack in Syria, there has been a heated exchange of words between global leaders, questioning Russia and Iran’s support to the Syrian president. President Donald Trump threatened Russia of striking missiles on Syria, in response to Russian ambassador’s threat to strike down any American crafts attacking Syria (read: Russia ETFs Hit by Sanctions and Syria Attack)

Moreover, the ongoing tensions involving Yemen Houthis and Saudi Arabia have contributed to crude’s rally. Saudi air defense forces intercepted at least three ballistic missiles fired by Yemen's Houthis, aimed at Saudi cities. Further strength in crude will add to price pressures and help inflation tick up, which in turn might prompt the Fed to go aggressive on interest rates (read: Are TIPS ETFs the New Safe Haven?).

Let us now discuss a few ETFs likely to see a surge in demand given the current market sentiments.

Vanguard Short-Term Inflation-Protected Securities ETF (VTIP - Free Report)

This ETF focuses on providing exposure to short-term TIPS, whose face value is indexed to inflation.

It has AUM of $4.8 billion and is a relatively cheaper bet as it charges a fee of 6 basis points a year. The fund has a weighted average maturity of 2.6 years and an effective duration of 2.6 years as well. VTIP has returned 0.3% year to date and the same in a year.

iShares 1-3 Year Treasury Bond ETF (SHY - Free Report)

This fund seeks to provide exposure to short-term U.S. Treasury bonds. If rates are hiked faster than expected, short-term bonds will do a great job in protecting investors from the impact of rate hikes, since these are less sensitive to interest rate changes.

With $12.0 billion in AUM, it charges a fee of 15 basis points a year. It has an effective duration of 1.92 years and a weighted average maturity of 1.98 years. The fund has lost 0.2% in a year as well as in the year-to-date frame.

Sit Rising Rate ETF (RISE - Free Report)

RISE seeks to profit from rising rates by tracking the Benchmark Portfolio Index before fees and expenses. The benchmark consists of exchange traded futures contracts and options on futures on two and five-year U.S. treasury contracts.

It has AUM of $41.6 million and charges a fee of 43 basis points a year. RISE has returned 3.2% year to date and 5.6% in a year.

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