Minutes from the July Federal Reserve meeting, released on Aug 18, hinted at the inclination to start tapering asset purchases before the end of the year. However, this does not mean any likelihood of the interest rate hikes. The minutes also noted that “some” members chose to wait until early in 2022 to begin QE tapering, as quoted on a CNBC article. The minutes indicated that the economy had touched its inflation target and was “close to being satisfied” with the development on job growth.
Few days back, Atlanta Federal Reserve Bank President Raphael Bostic said he is eyeing the fourth quarter for the start of a bond-purchase taper but can support an even earlier start if the job market records faster improvement. Fed officials have indicated repeatedly that tapering will occur first, with interest rate hikes unlikely until the process has been finished.
If QE tapering happens soon, interest rates in the United States are likely to go up. Against this backdrop, below we highlight a few ETFs that could be the winning picks if the Fed tapers soon.
ETFs in Focus
iShares Russell 2000 Value ETF IWN
Small-caps stocks tend to outperform in a growing domestic economy. Rapid vaccination and stimulus rollout are great positives for the segment. Honing in on the value spectrum in the small-cap segment would be a great idea amid taper tantrum. Value stocks tend to perform in a rising rate environment. This is especially true given the fund IWN is heavy on Financials – a sector that is a great beneficiary of rising rates.
Schwab U.S. Dividend Equity ETF (SCHD)
With the 10-year Treasury yield (1.27% as on Aug 18) crossing the S&P 500 dividend (about 1.25%), income-loving investors would definitely look for other better options. SCHD yields 2.82% currently. Plus, the dividend payout scenario has also improved within corporate America.
SPDR S&P Bank ETF (KBE)
As banks fare well in a steepening yield curve environment, KBE has chances of gaining ahead. As banks seek to borrow money at short-term rates and lend at long-term rates, a steepening yield curve will earn more on lending and pay less on deposits, thereby leading to a wider spread. This will expand net margins and increase banks’ profits.
Invesco Senior Loan ETF BKLN
Senior loans are floating rate instruments and thus pay a spread over the benchmark rate like LIBOR, which help in eliminating interest rate risk. This is because when interest rate rises, coupons on senior loans increase while the value of the bonds decline, keeping investments stable. Since these loans are issued by companies with below investment grade credit ratings, they usually pay yields to compensate for the risk.
Given this, senior loans and the related ETFs offer higher yields along with protection against any interest rate rise, making these ideal investments. Further, they carry lower credit risk than most other assets, with a similar level of yield and have low correlations with the other asset classes. Hence, investors can definitely play BKLN, which yields 3.20% annually.
iShares TIPS Bond ETF TIP
Since inflation is rising, inflation protected TIPS ETF could be a winning bet. The underlying Bloomberg Barclays U.S. Treasury Inflation Protected Securities (TIPS) Index (Series-L) measures the performance of the inflation-protected public obligations of the U.S. Treasury. The fund yields 3.10% annually (read: Why This is The Time for TIPS ETFs).
iShares Floating Rate Bond ETF (FLOT)
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. FLOT has an effective duration of 0.10 years and thus presents minimal interest rate risks.
Invesco QQQ Trust (QQQ)
The tech-heavy Nasdaq calls for a great long-term investment story. The fund houses the world’s most cash-rich stocks like Apple, Microsoft and Amazon. So, even if growth stocks in general depend on cheap money, rising rate worries are more of a threat for smaller tech companies. Such cash-rich bellwethers wouldn’t feel the heat that much. Rather these will continue to focus on the growing emergence of disruptive technologies.
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iShares TIPS Bond ETF (TIP): ETF Research Reports
SPDR S&P Bank ETF (KBE): ETF Research Reports
iShares Russell 2000 Value ETF (IWN): ETF Research Reports
iShares Floating Rate Bond ETF (FLOT): ETF Research Reports
Invesco Senior Loan ETF (BKLN): ETF Research Reports
Schwab U.S. Dividend Equity ETF (SCHD): ETF Research Reports
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