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ETFs to Gain/Lose if Fed Turns Hawkish for 2018

Sweta Killa
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All eyes are currently on the crucial two-day FOMC meeting slated to start today as the central bank is highly anticipated to raise interest rates by a quarter percentage point to 1.25-1.5% for the third time this year. Per the latest CME Group's FedWatch tool, the odds of a December rate hike is 96%. The Fed funds’ futures market shows 100% chance of a liftoff (read: December Rate Hike May Boost These ETFs).

Investors are also keenly awaiting the Fed’s guidance on the 2018 rate trajectory.

Hawkish Views for 2018

Fed officials are expecting three rate hikes next year while a few firms like Goldman GS and Deutsche Bank DB predict faster rate hikes, may be up to four times, as the U.S. economy is heading into 2018 with strong momentum that is likely to boost wages and inflation.

Meanwhile, Wall Street economists such as Citigroup C and JPMorgan Chase JPM are bracing for the biggest tightening of monetary policy in more than a decade. Average interest rates across advanced economies will likely climb to at least 1% next year to what would be the largest increase since 2006.

This is especially true as the world’s largest economy is expanding at the fastest clip in three years with the best back-to-back quarters of at least 3% GDP growth and is near full employment confirmed by a strong November jobs report. Unemployment dropped to the lowest level since December 2000 to 4.1% (read: Sector ETFs to Win on Strong November Job Data).

Further, Americans are highly optimistic about the economy with consumer confidence climbing to the highest level in 17 years. Moreover, Trump’s pro-growth policies to slash corporate taxes are nearing approval in Congress. If this happens, we will see an economic surge, boosting job growth and inflation. This signals faster rate increases in the coming years.

Given the expectation of a tighter monetary policy, several ETFs are in focus ahead of the Fed meeting. A few ETFs will be rewarded if the Fed gives hawkish signals while a few will be severely impacted. Let’s have a look at both:

ETFs to Gain

Financial Select Sector SPDR Fund XLF

A rising interest rate scenario would be highly profitable for the financial sector as a whole. This is because higher rates would bolster profits for banks, insurance companies and discount brokerage firms. The ultra-popular XLF, having AUM of $33.3 billion and average daily volume of 58 million shares, follows the Financial Select Sector Index. It holds 67 stocks in its basket with double-digit allocation to the top two firms Berkshire Hathaway Inc. BRK.B and JPMorgan Chase. In terms of industrial exposure, banks take the top spot at 44.6% while capital markets, insurance and diversified financial services make up for a double-digit exposure each. The fund charges 14 bps in annual fees and has a Zacks ETF Rank #2 (Buy) with a Medium risk outlook (read: 4 Sector ETFs & Stocks Set to Explode Higher on Tax Cuts).

PowerShares DB US Dollar Bullish Fund UUP

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 $596.3 million while sees an average daily volume of around 1.1 million shares. It charges 80 bps in total fees and expenses, and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook.

Deutsche X-trackers MSCI EAFE Hedged Equity ETF DBEF

The diverging policy in the United States and the rest of the world would 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 944 securities in its basket, with none accounting for more than 1.8% share. It is skewed toward the financial sector with 21.3% of the portfolio, while industrials, consumer discretionary, and consumer staples round off the next three spots with double-digit exposure each. Among countries, Japan takes the top spot at 24.3%, closely followed by United Kingdom (17.4%) and France (10.8%). The ETF has AUM of $7 billion and trades in solid volume of nearly 1.7 million 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


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 do. So, products tracking this bullion like GLD will lose. 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 the ultra-popular gold ETF with AUM of $34 billion and average daily volume of around 7.1 million shares a day. Expense ratio comes in at 0.40%. The fund has a Zacks ETF Rank #3 with a Medium risk outlook (read: November ETF Asset Report: U.S. Tops, Treasuries Flop).

iShares iBoxx $ High Yield Corporate Bond ETF HYG

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 Treasury notes, thereby fading the monopoly of high-yield bonds. HYG is the largest and most liquid fund in in the high-yield bond space with AUM of $19.2 billion and average daily volume of around 10.9 million shares. It tracks the Markit iBoxx USD Liquid High Yield Index and holds 1,030 securities in the basket. Effective duration and average maturity come in at 3.63 and 4.23 years, respectively. The ETF charges 49 bps in fees per year and has a Zacks ETF Rank #4 (Sell) with a High risk outlook (see: Junk Bond ETFs Plunge to Seven-Month Low).

iShares MSCI Emerging Markets ETF EEM

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 72 bps in annual fees from investors. Holding 861 securities, the product is widely spread out across various securities with none holding more than 5.52% of assets but is tilted toward the information technology and financials sectors at 28.5% and 23.2%, respectively. Among the emerging countries, China takes the top spot at 30% while South Korea and Taiwan round off the next two spots with a double-digit exposure each. The fund has AUM of $35.7 billion and trades in heavy volume of more than 50.6 million shares a day on average. It has a Zacks ETF Rank #3 with a Medium risk outlook (read: ETF Winners & Losers as Dollar Hits 13-Year High).

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