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Sudden Dovish Yellen Testimony to Boost These ETFs

Sanghamitra Saha

After weeks of speculation over impending hawkish actions from the Fed, Yellen’s testimony suddenly came in dovish. Yellen also clarified the timing and procedure of the normalization of its $4.2-trillion balance sheet.

The central bank will probably start reducing its balance sheet later this year, but Yellen indicated that any acute economic crisis calling for a substantial rate cut would put the trimming of balance sheet on hold. However, the chair has full faith in the U.S. economic growth momentum with solid labor market, though she remains cautious about subdued inflation and wage growth.

Yellen indicated that since the neutral rate – at which economic growth matches its potential and inflation – “is currently quite low by historical standards, the federal funds would not have to rise all that much further to get to a neutral policy stance." The current target for the funds rate is 1—1.25%, while inflation is around 1.4%, as per CNBC.

Notably, 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 now intends to shrink the balance sheet going forward (read: Surprise ETF Winners Post Fed Hike).

Bond Market Behavior

As per Reuters,in late trading on July 12, the benchmark 10-year Treasury yield dropped to 2.302% reacting to the testimony, marking its lowest in two weeks. The two-year yield declined to a three-week low of 1.331%. Rate futures hinted at a 53% probability of a December rate hike, down from 60% before the testimony, according to CME Group's FedWatch program.

ETFs To Win

Long-Term U.S. Treasury Bonds on a Tear

As yields dropped, long-term bond ETFs gained strength and set out on their way to reverse recent losses (read: Bond ETFs Bull Run to End Finally?).

Long-term bond ETFs like Vanguard Extended Duration Treasury ETF EDV and PIMCO 25+ Year Zero Coupon US Treasury ETF ZROZ added about 0.9% each post Yellen’s comments.

Dow Hitting an All-Time High

Signals of a few more months of cheap money inflows prompted a stock rally. The key U.S. equity gauge, the S&P 500-base ETF SPDR S&P 500 ETF Trust SPY, gained about 0.7% on July 12. However, the real star was Dow Jones which sprinted to a record high on gradual rate hike indication. SPDR Dow Jones Industrial Average ETF DIA advanced 0.6% on July 12.

Rate-Sensitive Sectors Other Winners

Needless to say, sectors that perform well in a low interest rate environment and offer higher yield, gained on July 12. Since housing and safe sector utility are rate-sensitive, SPDR S&P Homebuilders ETF XHB and Vanguard Utilities ETF VPU added about 0.4% and 0.9%, respectively.

Emerging Market Another Leader

Since developed market investors tap relatively faster-growing emerging markets (EM) to earn higher yields, EM funds jumped on Yellen testimony. Leveraged ETF Direxion Daily MSCI EM Mkts Bull 3X ETF EDC gained over 5.8% on July 12 while regular EM ETF iShares MSCI Emerging Markets ETF EEM rose about 2%.

Dividend ETFs to Rise

If the low-yield environment lasts long,dividend ETFs like Vanguard High Dividend Yield ETF VYM will jump ahead. The fund added over 0.6% on July 12.

Large-Cap Growth May Move North

Since dollar remains subdued in a low-rate environment, large-cap stocks with considerable global exposure should gain strength. And in a growth-friendly monetary environment, investors can pick funds like Guggenheim S&P 500 Pure Growth ETF RPG, which added 1.2% on July 12 (read: 7 Large-Cap Growth ETFs That Are Sizzling).

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SPDR-DJ IND AVG (DIA): ETF Research Reports
SPDR-SP 500 TR (SPY): ETF Research Reports
SPDR-SP HOMEBLD (XHB): ETF Research Reports
VIPERS-UTIL (VPU): ETF Research Reports
VANGD-HI DV YLD (VYM): ETF Research Reports
VANGD-EX DUR TR (EDV): ETF Research Reports
GUGG-SP 500 PG (RPG): ETF Research Reports
DIR-EM BULL3X (EDC): ETF Research Reports
PIMCO-25Y ZERO (ZROZ): ETF Research Reports
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