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Hawkish Fed Sentiments Put These ETFs in Focus

Sanghamitra Saha

As widely expected, the Fed stayed put in its April meeting but showed faith in the U.S. economy and maintained its hawkish stance on monetary policy outlook. A soft GDP data for the first quarter and slower manufacturing activity couldn’t subdue the Fed’s optimistic view about the economy (read: GDP, Manufacturing Data Soften: ETFs to Play the Dip).

The Fed stated that “inflation measured on a 12-month basis recently has been running close to the committee’s 2 percent longer-run objective.” Moreover, the Fed said that the factors supporting consumption growth “remained solid,” as per an article published on Bloomberg.

Notably, the Fed effected the third rate hike (by a modest 25 bps to 0.75–1%) in a decade in its March meeting. Though the central bank did not indicate the timeline of the next rate hike, investors have started betting ‘on a move in June’ and chances of a June hike went up to 70% from about 67%.

The Fed is also mulling over a reduction in its $4.5-trillion balance sheet. In April, the Fed indicated that they may start unwinding by the end of 2017, though that hinges on economic conditions (read: Doves Turn Hawks: 5 Fed-Proof Bond ETFs to Buy).

The Fed announced three rounds of “quantitative easing" or QE from 2008 through 2012, buying mostly long-term Treasuries and mortgage backed securities and beefing up its portfolio. The move was aimed at goading economic activity.

Till now, the bank has been reinvesting the proceeds from these bonds and rolling them over instead of reducing the size of the balance sheet. However, it intends to shrink it going forward. Yield on the 10-year U.S. Treasury note rose 4 bps to 2.33% on May 3, 2017 from the previous day. Both three-month and two-year bond yields gained 3 bps each on May 3, 2017 from the previous day.

Market & ETF Impact

Some subtle moves in various markets and asset classes were also noticed. Sensing a hawkish hint from the Fed, Dollar ETF PowerShares DB US Dollar Bullish Fund UUP gained about 0.4% on May 3. As the dollar gained, gold prices slipped with gold bullion ETF SPDR Gold Shares GLD losing about 1.4% (read: Gold Mining Stocks & ETFs Fall Amid New EU Optimism, Weak Earnings).

Within stocks, the S&P-500 based fund SPDR S&P 500 ETF SPY lost over 0.1% while Nasdaq-based PowerShares QQQ ETF QQQ was down about 0.3% on May 3, 2017. However, Dow Jones-based ETF SPDR Dow Jones Industrial Average ETF DIA edged up 0.04%.

As bond yields moved up, financial stocks – which perform well in a rising rate environment – gained on May 3. This offered about 1% gains to PowerShares KBW Bank ETF KBWB, about 0.8% returns to SPDR S&P Bank ETF KBE and over 0.5% gains to iShares US Broker-Dealers & Secs Exchs IAI.

Intermediate-term bond ETF iShares 7-10 Year Treasury Bond IEF lost over 0.2% post Fed comments on May 3, 2017. Inverse bond ETF Barclays Inverse US Treasury Aggregate ETN TAPR, which looks to track the sum of returns of periodically rebalanced short positions in equal face values of each of the Treasury Futures contracts, also gained over 0.5% on May 3 (see all Inverse Bond ETFs here).

Emerging markets – another segment that falls out of favor in a policy tightening era – also lost some strength on May 3 despite strong fundamentals. iShares MSCI Emerging Markets EEM lost about 0.7% on May 3, 2017.

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