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Fed Hikes Rates But Offers Dovish Outlook: ETFs to Play

Sanghamitra Saha
Sector ETF report for RYF

Extinguishing a few investors’ hope and in move against President Trump, the Fed put the fourth-rate hike of the year into effect in its December meeting. The benchmark interest rate was raised by a modest 25 bps to 2.25-2.50%, reflecting the growth momentum of the U.S. economy and well-being of the labor market. It marked the ninth-rate hike since the first lift-off in December 2015.

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. Six members of the FOMC, however, still see three hikes in 2019 as suitable.

Inside the Moderation of Economic Forecast

The Fed 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 Fed, however, lifted the longer-run growth measure projection to 1.9% from 1.8%. 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.

Market Reaction

As the tightening move was largely expected and the Fed offers a pretty dovish rate outlook, U.S. treasury yields mostly saw a downturn. In fact, the yield on 10-year U.S. Treasury fell to 2.77% on Dec 19 from 2.98% recorded at the start of the month. In fact, iShares 20+ Year Treasury Bond ETF TLT added more than 1.3% on Dec 19.  Invesco DB US Dollar Bullish UUP was up 0.04% on Dec 19.

Flattening yield curve weighed on top U.S. equities ETFs like SPDR S&P 500 ETF SPY (down 1.6%) and SPDR Dow Jones Industrial Average ETF DIA (down 1.6%) and tech-heavy PowerShares QQQ ETF QQQ (down 2.5%). Howevere, all these funds gained after hours.

ETFs to Play

2018 has been pretty rocky for stocks due to rising rate worries but a dovish Fed may give equities a big push in 2019. Recessionary fears seem exaggerated given still-strong consumer spending. Government spending continues to provide the much-needed boost to the economy. Business investment moderated but strong enough to carry on growth, per some analysts. 

Against this backdrop, we highlight a few ETFs that could serve investors’ interest well.

Vanguard Value ETF VTV

Betting on large-cap value stocks in such an edgy time from the global market perspective looks like a great idea. The fund is heavy on the financials, healthcare and tech sectors (read: 5 Low P/E Lucrative Value ETF Picks).

PIMCO 25+ Year Zero Coupon US Treasury ETF ZROZ

The dovish rate outlook and geopolitical tensions should keep long-term U.S. treasury yields at check, thus benefiting the fund (read: Will Fed Play Santa Claus for Wall Street? ETFs in Focus).

Reality Shares Divcon Leaders Dividend ETF LEAD

Quality stocks like dividend growth is another good pick. Investors should note that the underlying index of LEAD — the Reality Shares DIVCON Leaders Dividend Index — invests in the largest U.S. companies that have the highest probability of raising dividends in the next 12 months (read: Why You Should Invest in Dividend Growth ETFs Now).

Invesco DWA Consumer Cyclicals Momentum ETF PEZ

An improving economy with a strengthening labor market and a moderately rising interest rate environment is great for consumer discretionary stocks. This is why investors may find PEZ an intriguing option.

Invesco Russell Mid-Cap Pure Growth ETF PXMG

While the U.S. economy has been on a strong growth path, some developed economies are still suffering and practicing easy money policy. In light of this, it is better to bet on mid-cap stocks that follow a middle-of-the-road approach. These stocks offer an exposure to domestic economic improvement as well as give an access to the easy money era of the foreign economies. The underlying index of PXMG is composed of securities with strong growth characteristics selected from the Russell Midcap Index (read: 5 Top Smart-Beta ETF Charts of 2018).