Yellen Gives Hawkish Signals: 5 ETF Plays

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Includes: FLTR, HYND, KBWB, SNLN, TAPR, TLT, UUP
by: Zacks Funds

Against widespread assumptions, the Federal Reserve chair Janet Yellen fanned the possibility of faster hikes in rates in the coming months. Though no timeline has been provided yet and the decision will be "data-dependent," the Fed indicated that a prolonged wait to eliminate accommodating monetary policy would be "unwise."

This is especially true given that the U.S. economy is improving steadily, the Trump presidency is pushing for fiscal stimulation and a protracted easing in monetary policies may eventually hurt the financial markets and shove the economy toward recession.

The Fed raised benchmark interest rates by a modest 25 bps to 0.50-0.75% in December 2016 for the second time after almost a decade, attesting the U.S. economy's growth momentum and the labor market's well-being, though both have room for improvement. The Fed then forecast three rate hikes in 2017.

Yellen also indicated that the future movement of the monetary policy largely depends on how the new government's fiscal policy shapes up. Yellen also put stress on 'gradual' rate hikes going forward.

However, many traders are now pricing two rate hikes this year in June and December, though many have started to take Yellen's comments as a prelude to a rate hike as soon as in March. Expectations for three rate hikes in 2017 rose to 41% from 33% on February 14, 2017. As per BlackRock, the possibility of a March rate hike is "firmly on the table."

PowerShares DB US Dollar Bullish ETF (NYSEARCA:UUP) gained over 0.2% on February 14, following the Fed's hawkish comments over policy tightening. The yield on the 10-year Treasury note rose 4 bps to 2.47% on February 14 from the day before.

Market Impact

A renewed Trump rally on hopes of tax cuts and expectations for more corporate profits kept the broader market charged-up despite Yellen's policy tightening comments. All three key U.S. equity gauges - the S&P 500, the Dow Jones Industrial Average and the Nasdaq were in the positive territory.

But the prospects of a rate hike appear quite unsettling for bond investors. iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT) dipped over 0.7% on rising yields. However, there are ways to profit from rising rates. Below we highlight a few ETF ways:

PowerShares KBW Bank ETF (NASDAQ:KBWB)

Financial stocks perform better in a rising rate environment. As a result, the financial sector rallied on February 14, 2017, following Yellen's comments. The earnings picture of the banking sector too came in decent this reporting cycle. So investors can definitely play the latest optimism over the sector by investing in KBWB. The fund has a Zacks Rank #2 (Buy).

Barclays Inverse U.S. Treasury Aggregate ETN (NASDAQ:TAPR)

The product looks to track the sum of the returns of periodically rebalanced short positions in equal face values of each of the Treasury futures contracts. It charges 43 bps in fees.

WisdomTree Negative Duration High Yield Bond ETF (NASDAQ:HYND)

As rates rise, bond prices fall, which results in capital losses for those who do not hold bonds until maturity. Since bond duration measures interest rate sensitivity, negative duration bond ETFs like HYND would be great tools in a rising rate environment. The fund yields about 4.78% annually, making it a great destination for earning current income.

VanEck Vectors Investment Grade Floating Rate ETF (NYSEARCA:FLTR)

Floating rate notes are investment grade bonds that 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, they are less sensitive to an increase in rates compared to traditional bonds. FLTR has an effective duration of 0.14 years and thus presents minimal interest rate risks.

Highland/iBoxx Senior Loan ETF (NASDAQ:SNLN)

Senior loans are issued by companies with below investment grade credit ratings. In order to make up for this high risk, senior loans normally have higher yields. Since these securities are senior to other forms of debt or equity, they give protection to investors in any event of liquidation. As a result, default risk is low for such bonds, even after belonging to the junk bond space.

Moreover, senior loans are floating rate instruments and provide protection from rising interest rates. In a nutshell, a relatively high-yield opportunity coupled with protection from the looming rise in interest rates should help the fund perform better in the first half of 2017. SNLN could thus be a good pick for the upcoming days. The fund yields around 4.39% annually.

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