Prospects of rising interest rates sooner than the market had become ready to expect will pull away the prop for equities and hence negative equities. The S&P500 (NYSEARCA:SPY) (NYSEARCA:IVV) (US); LON:CSPX (UK) has dropped to a seven week low, and is now flat on the year, weighing down global equities, i.e., iShares MSCI ACWI Index Funds (NASDAQ:ACWI) (US); Vanguard FTSE All World Index LON:VWRD (UK).
The increased chance of a Fed rate hike creates downside risk at the long end of the yield curves, e.g., iShares $ Treasury Bonds 20+ year (NYSEARCA:TLT) (US); LON:IDTL (UK), and for corporate bonds (e.g., iShares $ Corporate Bonds) (NYSEARCA:LQD) (US); LON:LQDE (UK). Perhaps most at risk are high-yield bonds with the double whammy of rate rises and on valuations where investor thirst for income has led to yields being potentially over-bid, e.g., iShares $ High Yield Corporate Bonds) (NYSEARCA:HYG) (US); LON:SHYU (UK). On the flipside, there is a potential offset as the improving economic backdrop could make the case for tightening spreads.
Within the bond sector, shorter duration bonds will be less exposed (e.g. iShares $ Treasury Bonds 1-3yrs (NYSEARCA:SHY) (US); LON:IBTS (UK).
An upward move in the Fed Funds rate would be positive for the dollar and hence short-dated/ultra-short dated treasuries, as the ability of earning risk-free returns on cash once again become a more likely prospect e.g., iShares Short Treasury Bonds (NYSEARCA:SHV) (US), PIMCO Enhanced Short Maturity Active (NYSEARCA:MINT) (US); iShares $ Ultrashort Bonds LON:ERND (UK).
On a relative basis, a Fed Funds hike may see relative weakness in Gold, i.e., SPDR Gold Shares (NYSEARCA:GLD) (US); ETFS Physical Gold LON:PHAU (UK)
On a sector specific-basis, rising rates is a positive indicator for net interest margins which is supportive for banks/financials, i.e., SPDR S&P Banks (NYSEARCA:KBE) (US); SPDR S&P US Financial Select Sector (NYSEARCA:XLF) LON:SXLF (UK), FRA:ZPDF.
By contrast a hike would be negative for long-duration/rate-sensitive sectors such as Utilities & Financials, Utilities Select SPDR ETF (NYSEARCA:XLU) (US); SPDR S&P US Financial Select Sector UCITS ETF LON:SXLU (UK), and FRA:ZPDU).
Property/real estate sector would likewise be negatively impacted as spreads between property yields over risk-free rate contracts: iShares Global REIT (NYSEARCA:REET) (US); iShares Developed Markets Property Yield LON:IWDP (UK). On the flip-side, any uptick in the economy could be an offsetting factor.
Risk assets love the "lower for longer" support of ultra-low interest rates. Readjustment to rising costs of capital could continue to be painful.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article has been written for a US and UK readership. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “NYSEARCA:” (NYSE Arca Exchange) for US readers; “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice.