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A Fixed-Income Play if Fed Keeps Rates Flat

This article was originally published on ETFTrends.com.

With the economy growing at a rampant pace, the capital markets are predisposed to the idea that the Federal Reserve will continue to raise rates, but the latest real estate data published by the Commerce Department could signal otherwise.

The Commerce Department revealed that sales of new homes dropped 5.3%--below a downwardly-revised May figure and representing an eight-month low. This, combined with the National Association of Realtors reporting that existing homes sales fell by 0.6% in June, could show possible cracks in the real estate market.

Related: Leveraging Up The Real Estate Trade

Meanwhile, as interest rates continue to rise, mortgage applications are falling. According to the Wall Street Journal, mortgage applications decreased 2.5% the week ending July 13 as reported by the Mortgage Bankers Association.

According to the National Association of Home Builders, housing comprises between 15-18% of GDP--a combination of residential investment and consumption spending on housing services. A lagging housing market could put Federal Reserve Chairman Jerome Powell on pause with respect to rate-raising if he sees the real estate sector in the rearview mirror while the rest of the markets pass by above the speed limit.

“The housing market led the general economy out of the recovery and now it’s leading” it toward a slowdown, said Zillow Senior Economist Aaron Terrazas.

In a flat rate environment, fixed-income investors can adjust their strategies to mitigate interest rate risk, especially if the economic activity slows and worse, monetary policy might even warrant a rate drop. In this case, fixed-income investors should give the  Vanguard Short-Term Corporate Bond ETF (VCSH) a look.

Related: The Secret to Investing in Real Estate ETFs

VCSH seeks to track the performance of a market-weighted corporate bond index with a short-term dollar-weighted average maturity--the Bloomberg Barclays U.S. 1-5 Year Corporate Bond Index. The index is comprised of U.S. dollar-denominated, investment-grade, fixed-rate, taxable securities with maturities between 1 and 5 years.

In an economic environment where rates are steady, VCSH contains debt holdings where interest rates are fixed, mitigating any interest rate risk if the Fed stands put or even lowers interest rates. In addition, the investment-grade component minimizes credit risk with debt issues that are less likely to default. Furthermore, maturities that don't exceed five years also means investors are protected from any bond market volatility with lesser duration.

For more fixed-income trends, visit the Fixed Income Channel.