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ETFs to Win & Lose as Third Rate Hike Looms

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All eyes are currently on the crucial two-day FOMC meeting (starting today) as the central bank is highly anticipated to raise interest rates for the third time this year by 25 bps. This would also mark the eight rate hike since December 2015. The Fed is also on track for the fourth hike in December.

Per the CME Group’s FedWatch Tool, interest rate futures traders are fully pricing in a third rate increase at the September meeting, while the probability of an additional hike in December rose to 72% (read: September Rate Hike Odds Rise: Top Sector ETF & Stock Picks).

Growing inflationary pressure and an improving economy is compelling the Fed for aggressive rates hike. In the latest Fed minutes, the Federal Open Markets Committee (FOMC) provided an upbeat view of the economy, solidifying chances of a rate hike at the September meeting.

The U.S. economy is witnessing the fastest pace of growth in nearly four years and the labor market has been on an expansionary mode, adding jobs for 95 consecutive months -- the longest growth streak. Additionally, Americans continue to be optimistic as evident from 18-year high consumer confidence in August. Tax cuts and increased government spending are spurring growth.

However, the positive effects are expected to fade next year thanks to Trump’s trade protectionism policy. The escalation in trade war fears will raise consumer prices for key goods and supplies, potentially hampering growth. As such, the Fed might slow down its rate hikes in 2019.

Given this, several ETFs are in focus and could see outsized volume, depending on the upcoming Fed decision. A few ETFs will continue to benefit if the Fed raises rates as expected, while a few would be severely impacted. Let’s have a look at them:

ETFs to Win

SPDR S&P Regional Banking ETF (KRE - Free Report)


A rising interest rate scenario would be highly profitable for banks as they seek to borrow money at short-term rates and lend at long-term rates. With the rise in short-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. In particular, the ultra-popular KRE, having AUM of $5.4 billion and average daily volume of 5.6 million shares, will benefit the most. The product follows the S&P Regional Banks Select Industry Index, holding 127 securities and charging investors 35 basis points a year in fees. It has a Zacks ETF Rank #1 (Strong Buy) with a High risk outlook (read: Here's Why Should You Buy Financial ETFs).

Invesco DB US Dollar Index Bullish Fund (UUP - Free Report)

Rising interest rates will pull in more capital into the country and lead to appreciation of the U.S. dollar. UUP is the prime beneficiary of a rising dollar as it offers exposure against a basket of six world currencies – euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. This is done by tracking the Deutsche Bank Long US Dollar Index Futures Index Excess Return plus the interest income from the fund’s holdings of U.S. Treasury securities. The fund has so far managed an asset base of $544.9 million while seeing an average daily volume of around 1 million shares. It charges 79 bps in total fees and expenses and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook (read: Dollar ETFs: Is the Run Over?).

Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF - Free Report)

The strength in dollar would knock down the returns of international investments and thus raise the appeal for currency-hedged ETFs. For those seeking exposure to the developed market with no currency risk, DBEF could be an intriguing pick. The fund follows the MSCI EAFE US Dollar Hedged Index and holds 942 securities in its basket. The ETF has AUM of $6 billion and trades in solid volume of nearly 993,000 shares a day. It charges 35 bps in fees per year from investors and has a Zacks ETF Rank #3 with a Medium risk outlook.

ETFs to Lose

SPDR Gold Trust ETF (GLD - Free Report)


Gold will be hit hard as higher interest rates would diminish the yellow metal’s attractiveness since it does not pay interest like fixed-income assets. So, products tracking this bullion like GLD will lose further. The fund tracks the price of gold bullion measured in U.S. dollars, and kept in London under the custody of HSBC Bank USA. It is an ultra-popular gold ETF with AUM of $28.6 billion and average daily volume of around 6.4 million shares a day. Expense ratio came in at 0.40%. The fund has a Zacks ETF Rank #3 with a Medium risk outlook (read: Trump's Tariff Threat Put Trade Talks at Risk: ETFs to Buy).

iShares iBoxx $ High Yield Corporate Bond ETF (HYG - Free Report)

The high-yield corner of the fixed income world is the most watched area ahead of the Fed meeting. This is because higher rates would raise yields on the Treasury notes, thereby fading the sole lure of the high-yield bonds. HYG is the largest and most-liquid fund in in the high yield bond space with AUM of $15 billion and average daily volume of around 12.4 million shares. It charges 49 bps in fees per year from investors. The fund tracks the Markit iBoxx USD Liquid High Yield Index and holds 994 securities in the basket. The ETF has a Zacks ETF Rank #4 (Sell) with a High risk outlook.

iShares MSCI Emerging Markets ETF (EEM - Free Report)

A rate hike would pull out more capital from the emerging markets, stirring up concerns for most nations. The most popular emerging market ETF – EEM – tracks the MSCI Emerging Markets Index and charges 69 bps in annual fees from investors. It holds 976 securities and has AUM of $31 billion. The product trades in average daily volume of more than 68.6 billion shares and has a Zacks ETF Rank #3 with a Medium risk outlook (read: EM ETFs: A Contrarian Bet or Value Trap?).

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