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Dovish Fed Minutes Should Boost These ETFs

Sanghamitra Saha
Smart Beta ETF report for IHDG

The latest Fed minutes came out as dovish for investors asofficials acknowledged that the course of policy ahead is “less clear.” The Fed hiked rates four times in 2018 with the latest being enacted in December. However, the guidance for 2019 was a little soft as the U.S. central bank cut its view for interest rate hikes next year from three to two.

According to the minutes of the Fed’s December gathering released on Jan 9, still-subdued inflation led the central bank to think about a “patient” approach to future rate hikes. Many private economists believe that the Fed may end up raising rates just once instead of two this year if the economy slows.

James Bullard, the president of the Federal Reserve Bank of St. Louis and a voting member this year on the FOMC, commented that further rate hikes from this level could push the U.S. economy into a recession.

Inside the Moderation of Economic Forecast

Investors should note that, in December, the Fed also lowered its forecast for 2018 real GDP growth from 3.1% in September to 3.0% and from 2.5% to 2.3% for 2019 but maintained the 2020 growth forecast at 2.0%. The central bank also maintained projections for 2021, which calls for economic growth of 1.8%.

PCE inflation expectations were lowered to 1.9% from 2.1% for 2018 and to 1.9% from 2.0% for 2019. Federal funds rate projections for 2018, 2019 and 2020 were maintained at 2.4%, lowered to 2.9% from 3.1% and to 3.1% from 3.4%, respectively. For the longer term, the rate is projected at 2.8%, down from 3.0% projected in September. Labor market projections remained pretty stable for the near term (read: 5 Sector ETFs & Stocks to Shine on Upbeat December Jobs Data).

Market Behavior

Post dovish Fed minutes, funds on key equity gauges like SPDR S&P 500 ETF (SPY) gained about 0.5% on Jan 9, SPDR Dow Jones Industrial Average ETF DIA added about 0.4% and Invesco QQQ ETF QQQ gained about 0.8%, respectively, on Jan 9, 2018. iShares 20+ Year Treasury Bond ETF TLT lost about 0.2% while global fund iShares MSCI ACWI ETF ACWI added about 0.9% (read: Risk-On Trade is Back: ETFs That Gained the Most).

In contrast to 2018 trends, yield curve is steepening. Yields on three-month, six-month and one-year Treasuries have fallen on Jan 9 while long-term bond yields have been on a gradual rise. 

Since several market participants including analysts at Rabobank believe that the implied probability of a Fed rate hike in March is now zero, markets should see an uptrend right now. Against this backdrop, below we highlight a few ETFs that could prove to be winning bets in the current scenario (read: Stocks & ETFs to Pick From Goldman Sachs' Favored List in 2019).

iShares Edge MSCI USA Momentum Factor ETF (MTUM)

The underlying index measures the performance of U.S. large and mid-capitalization stocks exhibiting relatively higher momentum characteristics. The fund charges 15 bps in fees.

SPDR S&P Bank ETF (KBE)

A steepening of the yield curve is good for banking stocks. The underlying S&P Banks Select Industry Index is a modified equal-weighted index that looks to reflect the performance of publicly traded companies that do business as banks or thrifts.

Vanguard Small Cap Growth ETF (VBK)

The outlook for relatively easy money policy and an upbeat U.S. economic growth momentum should bode well for domestically focused small-cap stocks. The fund charges 7 bps in fees.

Xtrackers MSCI Emerging Markets ESG Leaders Equity ETF (EMSG)

Since a dovish Fed is likely to keep the greenback lower, emerging markets should see smooth trading. The product charges 20 bps in fees.

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