As expected, the Fed has raised interest rates for the second time this year by 25 bps to 1.75-2%. This also marks the seventh rate hike since December 2015. The central bank signaled a hawkish outlook tweaking its language for economic growth to “rising at a solid rate" from “moderate” provided in May (read: June Rate Hike in the Cards: ETFs to Win & Lose).
It also dropped its word "stayed low" for unemployment and “moderated” for household spending. The Fed now believes that the unemployment rate has "declined” and household spending "has picked up." All these indicate two more lift-offs that would translate into four total increases in 2018.
The Fed Chair, Jerome Powell, stated that the economy had strengthened significantly since the 2008 financial crisis and is approaching a “normal” level that could allow the Fed to soon step back and play less of a hands-on role in encouraging economic activity. This reflects optimism about the health of the economy and a faster-than-expected rates hike that would shoot up the borrowing cost for cars, home mortgages and credit cards over the next year (read: Time to Buy Consumer Discretionary ETFs: 5 Top Picks).
The Fed also raised its forecast for GDP growth to 2.8% for this year compared with the previous expectation of 2.7% and lowered the expectation for unemployment rate to 3.6% from 3.8%. Additionally, inflation forecast rose to 2.1% for this year through 2021.
Coming to unwinding of the balance sheet, the Fed will increase the monthly cap of its $4.4 trillion balance sheet shrinkage by $10 billion per month beginning in July, bringing the total monthly reduction of its balance sheet to $40 billion from $30 billion as of June. This move will continue to push long-term rates higher.
A Boon for Banks
A rising rate environment is highly beneficial for cyclical sectors like financial, technology industrials and consumer discretionary but banks are in the most advantageous position. This is because they seek to borrow money at short-term rates and lend at long-term rates. With the steep rise in long-term interest rates, banks would be able to earn more on lending and pay less on deposits. This would expand net margins and bolster banks’ profits (see: all the Financial ETFs here).
While focusing on a particular stock in this space is certainly an option, investing in a basket of stocks via ETFs could lead to risk-adjusted returns. Given this, we have highlighted five bank ETFs that would gain from a hawkish Fed and have a solid Zacks ETF Rank #1 (Strong Buy) or #2 (Buy).
SPDR S&P Regional Banking ETF (KRE - Free Report)
This fund, having AUM of $5.3 billion and average trading volume of around 6.2 million, offers exposure to the regional banks. It follows the S&P Regional Banks Select Industry Index, charging investors 35 basis points a year in fees. Holding 120 securities in its basket, the fund is widely spread out with each security holding less than 2.3% of assets. The fund has risen 9.7% so far this year and has a Zacks ETF Rank #1.
iShares U.S. Regional Banks ETF (IAT - Free Report)
This ETF offers exposure to 53 small and mid-cap regional bank stocks by tracking the Dow Jones U.S. Select Regional Banks Index. It is largely concentrated on the top two firms, US Bancorp (USB - Free Report) and PNC Financial Services (PNC - Free Report) , with a combined 25% of assets. Other firms hold no more than 7.01% share. The fund has amassed $930.8 million in its asset base while sees a good volume of 182,000 shares a day. It charges 44 bps in annual fees and has gained 5.8% so far this year. IAT has a Zacks ETF Rank #1.
Invesco KBW Regional Banking ETF (KBWR - Free Report)
This fund follows the KBW Regional Banking Index, holding 50 stocks in its basket, with each accounting for less than 4% share. It is relatively less popular and less liquid options in the space, with AUM of $193.4 million and average daily volume of 17,000 shares. It charges 35 bps in fees per year from investors and is up 8% in the year-to-date time frame. The product has a Zacks ETF Rank #2 (read: Regional Bank ETFs: What Investors Need to Know).
SPDR S&P Bank ETF (KBE - Free Report)
This fund offers equal weight exposure to 77 banking stocks by tracking the S&P Banks Select Industry Index. Regional banks dominate the portfolio with 79% share while diversified banks, thrifts & mortgage finance, asset management & custody banks and other diversified financial services take the remainder. It has amassed $3.9 billion in its asset base while trades in heavy volume of 2.4 million shares a day on average. The product has gained 5.6% so far this year and sports a Zacks ETF Rank #1.
Invesco KBW Bank ETF (KBWB - Free Report)
This fund provides exposure to the 24 leading national money centers and regional banks or thrifts by tracking the KBW Bank Index. It is concentrated on the top five firms that make up for more than 7% share each. The fund has managed $1.1 billion in its asset base and trades in solid volume of 530,000 shares per day on average. Expense ratio comes in at 0.35%. KBWB has added 2.5% in the year-to-date time frame and has a Zacks ETF Rank #1.
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