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The Sector ETFs the Fed Forgot to Boost


When the Federal Reserve announced Wednesday that it will not move to reduce its $85 billion-per-month bond-buying program, U.S. stocks raced to record highs. Rate-sensitive sectors such as utilities soared. Commodities rallied as the U.S. dollar tanked. Finding sector ETFs that did not benefit from the no tapering announcement was difficult. Unfortunately for a few sector funds, the Fed news did more harm than good and on a day when U.S. stocks staged an epic rally, these ETFs were left behind.

Regional bank ETFs have the dubious honor of being among on Wednesday’s worst non-inverse ETF performers. The laggard status of these ETFs is easily explained. While the financial services sector at large has delivered solid returns this year, there were fears that higher interest rates could pressure earnings at the largest U.S. banks such as Bank of America (BAC), J.P. Morgan Chase and Citigroup (NYSE: C). On the other hand, regional banks were embraced as beneficiaries of rising rates. [Regional Bank ETFs Showing Promise as Rates Rise]

While regional bank ETFs, such as the SPDR S&P Regional Bank ETF (KRE), benefited from improving housing data, traders and investors bid these funds higher on the basis that higher interest rates would lead to increased net interest margin for regional banks. [Regional Bank ETFs in Focus on Higher Rates]

Prior to Wednesday, 10-year Treasury yields surged almost 31% in the previous three months. Over the same time, KRE soared 10%. Highlighting the correlation between regional banks and higher rates, 10-year yields plunged almost 5.1% on Wednesday, a move that sent KRE down 0.8% on volume that was more than double the daily average.

Making the move lower for regional bank ETFs look all the worse is that the Financial Select Sector SPDR (XLF) gained 0.9% on heavy volume while the Vanguard Financials ETF (VFH) rose 1.1%. Those ETFs do have some regional exposure, but are dominated by the BofA’s, Citigroups and J.P. Morgans of the world.

Of the three main regional bank ETFs, only the PowerShares KBW Regional Banking Portfolio (KBWR) finished higher Wednesday, but KBWR closed near its low of the day. The iShares U.S. Regional Banks ETF (IAT) lost 0.26% on the day.

If the Fed’s no tapering pledge flattens the yield curve, regional banks could be vulnerable because flatter yield curves reduce the spreads at which regionals can borrow and lend, adversely affecting profits in the process.

SPDR S&P Regional Bank ETF

ETF Trends editorial team contributed to this post. Tom Lydon’s clients own shares of KRE.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.