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If Fed Maintains Dovish Outlook, Profit from These ETFs

Sweta Killa

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 for the second time this year. Per the latest CME Group's FedWatch tool, the odds of a June rate hike is 98%.

However, chances of further rate hikes this year are dim. A Reuter’s poll showed that conviction has faded for Fed rate hikes beyond June while many analysts, including Fidelity International’s global economist Anna Stupnytska and Christopher Whalen, believe that the June rate hike would be the last for 2017.

Further Rate Hike Dims

Markets are speculating that the Trump administration will continue to face hurdles in getting its tax and healthcare reforms passed by the Congress. The latest round of economic data has also been mixed with inflation particularly bad. The Fed's preferred measure of underlying inflation has dropped to 1.5% through April, the slowest pace since December 2015, from 1.8% earlier this year.

Additionally, the consumer confidence survey was negative for two consecutive months with the Consumer Confidence Index slipping to 117.9 in May from 120.3 in April and 125.6 in March, the highest level since December 2000. While the economy is rebounding in the second quarter after paltry 1.2% growth in the first, GDP growth is expected to fell short of Trump’s growth target of 3%.

Further, U.S. job data for the month of May was disappointing as the economy added just 138,000 jobs, falling short of analysts’ expectation. Additionally, both March and April job gains were revised down by 66,000. However, the unemployment rate dropped to 4.3%, the lowest level since 2001, and average hourly earnings rose 0.2%, bringing the year-over-year wage growth to 2.5%, much better than the previous years (read: 4 ETFs Set to Gain on Dismal May Job Data).

Hints from Last Fed Minutes

The last Fed minutes hinted at a June rate hike but cast doubts on further increases this year. This is especially true as the Fed intends to start shrinking its $4.5 trillion balance sheet of Treasury debt and mortgage-backed securities, most of which are loaded after the financial crisis, to keep the rates low and bolster the economy by the end of the year.

The unwinding of the balance sheet will reduce chances of further rate hikes this year and would boost longer-term rates. As such, investors are looking for more information on the timing and details of the Fed’s previously announced plans to shrink its balance sheet (read: Fed to Tighten Policy: Bet on These ETFs).

Given this, some ETFs will benefit if the Fed remains dovish on future rate hikes. Let’s have a look at them:

SPDR Gold Trust ETF GLD

Gold will regain its lost sheen as subdued interest rates would increase the metal’s attractiveness and the product tracking this bullion like GLD will gain. 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 $35.5 billion and average daily volume of around 7.8 million shares a day. Expense ratio comes in at 0.40%. The fund has a Zacks ETF Rank of 3 with a Medium risk outlook (read: 5 Reasons Why Gold ETFs May be Up for a Rebound).

iShares Mortgage Real Estate Capped ETF REM

Mortgage REITs would gain if the Fed starts shrinking its balance sheet and gives a dovish outlook for this year’s rate hikes. This is because long-term rates would rise faster than short-term rates, thereby leading to a wide spread and higher profits for mREIT companies. REM is the most popular mortgage REIT ETF with AUM of $1.4 billion and average daily volume of around 318,000 shares. It tracks the FTSE NAREIT All Mortgage Capped Index and holds 34 securities in its basket with large allocations to the top two firms – Annaly Capital NLY and American Capital Agency AGNC – that collectively make up for 29.1% share while other securities hold less than 8.5% share. The fund charges 48 bps a year as fees and has a Zacks ETF Rank of 3 with a Medium risk outlook.

SPDR Bloomberg Barclays Short Term High Yield Bond ETF SJNK

The high yield corner of the fixed income world is the most watched area ahead of the Fed meeting. This is because the dovish outlook would result in lower Treasury yields, thereby raising the appeal for high-yield bonds. In particular, short-term high yield ETFs will be the biggest beneficiaries. That being said, SJNK is one of the largest and most liquid funds in the high yield bond space with AUM of over $4 billion and average daily volume of around 1.7 million shares. It charges 40 bps in fees per year from investors. The fund tracks the Bloomberg Barclays US High Yield 350mn Cash Pay 0-5 Yr 2% Capped Index and holds 777 securities in the basket. The modified duration and average maturity comes in at 2.09 and 3.31 years, respectively. It has a Zacks ETF Rank of 3 with a High risk outlook.

iShares MSCI Emerging Markets ETF EEM

Emerging market stocks will get a boost, as a dovish rate hike path would inject more capital into these nations. The ultra-popular ETF – EEM – tracks the MSCI Emerging Markets Index and holds 854 securities with none holding more than 4.3% of assets. However, the product is tilted toward the information technology and financial sectors at 24.9% and 23.4%, respectively, while the other sectors make up for a nice mix in the portfolio. Among the emerging countries, China takes the top spot at 27.2% while South Korea and Taiwan round off the next two spots with a double-digit exposure each. The fund has AUM of $32 billion and average daily volume of about 52.1 million shares. It charges 72 bps in annual fees and has a Zacks ETF Rank of 3 with a Medium risk outlook (read: Can Emerging Market ETFs Retain Their Mojo in 2017?).

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