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Rates to Stay Higher for Longer? ETF Strategies to Play
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The Fed's Neel Kashkari believes that it's likely that the Fed will cut interest rates once in 2024, possibly in December. The Fed has held rates steady in the 5.25%-5.50% range since July last year to manage inflation pressures. Kashkari stressed on the need for more evidence that inflation is trending back towards the Fed's 2% target before making rate cut decisions.
Economic Outlook
Despite recent rate hikes, Kashkari noted the surprising resilience of the U.S. job market. He anticipates a gradual cooling of economic activity towards a more balanced state. Inflation, as measured by the Fed's preferred metric, the personal consumption expenditures price index, stood at 2.7% in April, slightly above the 2% target.The unemployment rate rose slightly to 4% in May but remains below sustainable levels.
Housing Market Concerns
Kashkari addressed concerns about high borrowing costs impacting homebuyers. He believes that lowering rates now might inflate housing prices without improving affordability. Instead, he emphasized the importance of reducing inflation to support sustainable economic growth and housing market stability.
Rate Cut Probability
Traders now see a nearly 61.1% chance of a September rate reduction, according to the CME's FedWatch tool, compared with 45.1% one week ago. However, the rate cut by December is almost certain. There is only a 4.5% chance of rates remaining in the current range, down from 12.9% recorded last week. There is 44.7% probability of rates diving by 50 bps in December, up from 35.6% recorded a week ago.
ETF Strategies to Play
Given this, investors must be interested in finding out all possible strategies to weather a rise in interest rates. For them, below we highlight a few investing tricks that could gift investors with gains in a rising rate environment.
Tap Senior Loan ETFs
Senior loans are floating rate instruments thus providing protection from rising interest rates. This is because senior loans usually have rates set at a specific level above LIBOR and are reset periodically which help in eliminating interest rate risk. Further, as the securities are senior to other forms of debt or equity, senior bank loans offer lower default risks even after belonging to the junk bond space.
Virtus Seix Senior Loan ETFSEIX, which yields about 9.02% annually and Invesco Senior Loan ETF (BKLN - Free Report) , which yields 8.82% annually are good picks here.
Play Floating Rate Bond ETFs
The floating rate bond has been an area to watch lately amid rising rate environment. Floating rate bonds are investment grade and do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of issuers.
Since the coupons of these bonds are adjusted periodically, these are less sensitive to an increase in rates compared to the traditional bonds. Unlike fixed-coupon bonds, these do not lose value when the rates go up, making the bonds ideal for protecting investors against capital erosion in a rising rate environment.
iShares Floating Rate Bond ETF (FLOT - Free Report) (yields 5.90% annually) and iShares Treasury Floating Rate Bond ETF (TFLO - Free Report) (yields 5.29% annually) are two examples in this category.
Time for Cash-Like ETFs?
We believe cash and short-dated fixed income may play a greater role in adding stability to a portfolio. This is especially true given that the Fed may keep rates higher for longer and short-term bond yields may stay high. That would result in a similar rate for cash-like assets such as money-market funds.
Investing options include JPMorgan UltraShort Income ETF (JPST) (yields 5.20% annually), Invesco Global Short Term High Yield Bond ETF (PGHY - Free Report) (yields 8.16% annually), and Fidelity Low Duration Bond Factor ETF (FLDR - Free Report) (yields 5.52% annually). Such short-term bond ETFs also have lower interest rate sensitivity.
Hedge Rising Rates With Niche ETFs
There are some niche ETFs that guard against rising rates. These ETF options are: Simplify Interest Rate Hedge ETFPFIX, Global X Interest Rate Hedge ETF (RATE) and Foliobeyond Rising Rates ETFRISR. ETFs like PFIX, RATE, RISR yield 8.89%, 4.38%, 7.25% annually.
Go Short with Rate-Sensitive Sectors
Needless to say, sectors that perform well in a low interest rate environment and offer higher yield, may falter when rates rise. Since real estate is such a sector, it is better to go for inverse REIT ETFs. ProShares UltraShort Real Estate (SRS) , ProShares Short Real Estate (REK) are such inverse ETFs that could be wining bets in a rising rate environment.
Short U.S. Treasuries
Plus, shorting U.S. treasuries is also a great option in this type of a volatile environment. The picks include ProShares UltraShort 20+ Year Treasury ETF (TBT - Free Report) , Direxion Daily 20+ Year Treasury Bear 3x Shares (TMV - Free Report) and ProShares UltraShort 7-10 Year Treasury (PST - Free Report) .
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Rates to Stay Higher for Longer? ETF Strategies to Play
The Fed's Neel Kashkari believes that it's likely that the Fed will cut interest rates once in 2024, possibly in December. The Fed has held rates steady in the 5.25%-5.50% range since July last year to manage inflation pressures. Kashkari stressed on the need for more evidence that inflation is trending back towards the Fed's 2% target before making rate cut decisions.
Economic Outlook
Despite recent rate hikes, Kashkari noted the surprising resilience of the U.S. job market. He anticipates a gradual cooling of economic activity towards a more balanced state. Inflation, as measured by the Fed's preferred metric, the personal consumption expenditures price index, stood at 2.7% in April, slightly above the 2% target.The unemployment rate rose slightly to 4% in May but remains below sustainable levels.
Housing Market Concerns
Kashkari addressed concerns about high borrowing costs impacting homebuyers. He believes that lowering rates now might inflate housing prices without improving affordability. Instead, he emphasized the importance of reducing inflation to support sustainable economic growth and housing market stability.
Rate Cut Probability
Traders now see a nearly 61.1% chance of a September rate reduction, according to the CME's FedWatch tool, compared with 45.1% one week ago. However, the rate cut by December is almost certain. There is only a 4.5% chance of rates remaining in the current range, down from 12.9% recorded last week. There is 44.7% probability of rates diving by 50 bps in December, up from 35.6% recorded a week ago.
ETF Strategies to Play
Given this, investors must be interested in finding out all possible strategies to weather a rise in interest rates. For them, below we highlight a few investing tricks that could gift investors with gains in a rising rate environment.
Tap Senior Loan ETFs
Senior loans are floating rate instruments thus providing protection from rising interest rates. This is because senior loans usually have rates set at a specific level above LIBOR and are reset periodically which help in eliminating interest rate risk. Further, as the securities are senior to other forms of debt or equity, senior bank loans offer lower default risks even after belonging to the junk bond space.
Virtus Seix Senior Loan ETF SEIX, which yields about 9.02% annually and Invesco Senior Loan ETF (BKLN - Free Report) , which yields 8.82% annually are good picks here.
Play Floating Rate Bond ETFs
The floating rate bond has been an area to watch lately amid rising rate environment. Floating rate bonds are investment grade and do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of issuers.
Since the coupons of these bonds are adjusted periodically, these are less sensitive to an increase in rates compared to the traditional bonds. Unlike fixed-coupon bonds, these do not lose value when the rates go up, making the bonds ideal for protecting investors against capital erosion in a rising rate environment.
iShares Floating Rate Bond ETF (FLOT - Free Report) (yields 5.90% annually) and iShares Treasury Floating Rate Bond ETF (TFLO - Free Report) (yields 5.29% annually) are two examples in this category.
Time for Cash-Like ETFs?
We believe cash and short-dated fixed income may play a greater role in adding stability to a portfolio. This is especially true given that the Fed may keep rates higher for longer and short-term bond yields may stay high. That would result in a similar rate for cash-like assets such as money-market funds.
Investing options include JPMorgan UltraShort Income ETF (JPST) (yields 5.20% annually), Invesco Global Short Term High Yield Bond ETF (PGHY - Free Report) (yields 8.16% annually), and Fidelity Low Duration Bond Factor ETF (FLDR - Free Report) (yields 5.52% annually). Such short-term bond ETFs also have lower interest rate sensitivity.
Hedge Rising Rates With Niche ETFs
There are some niche ETFs that guard against rising rates. These ETF options are: Simplify Interest Rate Hedge ETF PFIX, Global X Interest Rate Hedge ETF (RATE) and Foliobeyond Rising Rates ETF RISR. ETFs like PFIX, RATE, RISR yield 8.89%, 4.38%, 7.25% annually.
Go Short with Rate-Sensitive Sectors
Needless to say, sectors that perform well in a low interest rate environment and offer higher yield, may falter when rates rise. Since real estate is such a sector, it is better to go for inverse REIT ETFs. ProShares UltraShort Real Estate (SRS) , ProShares Short Real Estate (REK) are such inverse ETFs that could be wining bets in a rising rate environment.
Short U.S. Treasuries
Plus, shorting U.S. treasuries is also a great option in this type of a volatile environment. The picks include ProShares UltraShort 20+ Year Treasury ETF (TBT - Free Report) , Direxion Daily 20+ Year Treasury Bear 3x Shares (TMV - Free Report) and ProShares UltraShort 7-10 Year Treasury (PST - Free Report) .