The Federal Reserve Chair Jerome Powell in the Jackson Hole symposium on Friday warned that the central bank is prepared to raise interest rates further and keep the borrowing costs high until inflation comes in the target range of 2%. The Fed will pay close attention to economic growth and the state of the labor market while making policy decisions.
Insights into Economic Trends
While inflation is showing signs of cooling down, the economy has been growing faster than expected and consumers are spending briskly. These trends could keep inflation pressure high.
However, business surveys this week raised doubts about the economy’s strength in August, even as jobless claims remained near historic lows. U.S. business activity approached a stagnation point in August, with growth at its weakest since February as demand weakened for both manufactured goods and services. S&P Global said that its flash U.S. Composite PMI index, which tracks manufacturing and service sectors, fell to 50.4 in August from 52 in July, the biggest drop since November 2022.
Manufacturing PMI also fell deeper into contraction territory at 47.0 from 49.0 in July, the fourth straight month of contraction. Meanwhile, U.S. consumer sentiment slipped slightly in August, with the University of Michigan’s reading falling to 69.5 from 71.6 in July. The Fed has raised interest rates to 5.25-5.50%, the highest level since March 2001. Powell believes these rates are now sufficiently high to curtail growth.
Post Powell’s speech, futures contracts tied to the Fed policy rate priced in just less than a 20% chance of a rate hike in September but a more-than-50% chance of the policy rate ending the year in a 5.5%-5.75% range, a quarter-point higher than the current range.
Following the hawkish Powell speech, a few corners of the broad ETF investing world are in focus. Here are a few zones that could potentially experience the positive effects of a hawkish Fed.
Consumer Discretionary – Vanguard Consumer Discretionary ETF (VCR)
While rising interest rates can have negative implications for consumer spending, certain segments within the consumer discretionary sector are likely to benefit. Companies that offer luxury goods and services, such as high-end retailers, luxury automobile manufacturers, and leisure and entertainment providers, may experience increased demand as the economy strengthens and consumer confidence remains intact.
Vanguard Consumer Discretionary ETF follows the MSCI U.S. Investable Market Consumer Discretionary 25/50 Index and holds 309 stocks in its basket. In terms of industrial exposure, broad-line retail, automobile manufacturers and restaurants occupy the top spots with double-digit exposure each. Vanguard Consumer Discretionary ETF is the low-cost choice in the space, charging investors 10 bps in annual fees while volume is good at nearly 93,000 shares a day. The fund has managed $5 billion in its asset base so far. Vanguard Consumer Discretionary ETF has a Zacks ETF Rank #1 (Strong Buy) with a Medium risk outlook.
Industrials – Invesco DWA Industrials Momentum ETF (PRN)
Industrial sectors tend to benefit from the Fed’s hawkish stance as it reflects a stronger economy, which can lead to increased business investment, infrastructure spending and demand for durable goods. These industries tend to perform well during periods of economic expansion.
Invesco DWA Industrials Momentum ETF provides exposure to 45 industrial companies that are showing relative strength (momentum). It is widely spread across trading companies, construction & engineering, building products and aerospace & defense. Invesco DWA Industrials Momentum ETF has accumulated $150.2 million in its asset base and charges 60 bps in annual fees. It trades in an average daily volume of 5,000 shares and has a Zacks ETF Rank #2 (Buy).
Dollar – Invesco DB US Dollar Index Bullish Fund (UUP)
Rising interest rates will pull more capital into the country and lead to an appreciation of the U.S. dollar. Invesco DB US Dollar Index Bullish Fund is the prime beneficiary of a rising dollar as it offers exposure against a basket of six world currencies — euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. This is done by tracking the Deutsche Bank Long US Dollar Index Futures Index Excess Return plus the interest income from the fund’s holdings of U.S. Treasury securities.
Invesco DB US Dollar Index Bullish Fund has so far managed an asset base of $513.7 million while seeing an average daily volume of 1.2 million shares. It charges 77 bps in total fees and expenses, and has a Zacks ETF Rank #2 with a Medium risk outlook.
Floating Rate Bonds – iShares Floating Rate Bond ETF (FLOT)
Floating rate bonds are investment grade and 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. Unlike fixed-coupon bonds, these do not lose value when the rates go up, making the bonds ideal for protecting investors against capital erosion in a rising rate environment.
iShares Floating Rate Bond ETF follows the Bloomberg Barclays US Floating Rate Note < 5 Years Index and holds 337 securities in its basket. The fund has an average maturity of 1.68 years and an effective duration of 0.02 years. iShares Floating Rate Bond ETF has amassed $7.2 billion in its asset base while trading in a volume of 1 million shares per day on average. It charges 15 bps in annual fees.
Cash-Like ETFs – SPDR Bloomberg 1-3 Month T-Bill ETF (BIL)
In a higher interest rate scenario, cash and cash equivalents become more attractive relative to other investment options. Investors seeking stability and preservation of capital may opt to hold larger cash positions, which can be done by cash-like ETFs. These funds invest in ultra-short-term bonds and help investors to keep aside money for a couple of weeks to a few months with almost no risk.
SPDR Bloomberg 1-3 Month T-Bill ETF seeks to provide exposure to zero-coupon U.S. Treasury securities that have a remaining maturity of 1-3 months. It follows the Bloomberg 1-3 Month U.S. Treasury Bill Index, holding 19 securities in its basket. Average maturity and adjusted duration is 0.10 years each. SPDR Bloomberg 1-3 Month T-Bill ETF has AUM of $29.3 billion and an average daily volume of 6 million shares. It charges 13 bps in annual fees and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook.
SPDR Gold Trust ETF (GLD)
If the Fed does not raise rates, gold will rally as it will increase the yellow metal’s attractiveness since it does not pay interest like fixed-income assets. Therefore, products tracking this bullion, like SPDR Gold Trust ETF, will gain. It tracks the price of gold bullion measured in U.S. dollars, and kept in London under the custody of HSBC Bank USA. SPDR Gold Trust ETF is an ultra-popular gold ETF with an AUM of $54.5 billion and a heavy volume of about 5 million shares a day.
SPDR Gold Trust ETF charges 40 bps in fees per year from investors and has a Zacks ETF Rank #3 with a Medium risk outlook.
SPDR Gold Shares (GLD): ETF Research Reports
This article originally appeared on Zacks
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