Fed To Hike In June? Expected ETF Moves

Taking most investors by surprise, minutes from the Fed April meeting pointed to interest rate hike possibilities in June. While this seemed unfeasible a few days back, a volley of upbeat economic data lately sparked off possibilities for further policy tightening.

Also, plenty of positive vibes were felt in the market, including a healing labor market and the latest uptick in global sentiments buoyed by stabilization in China and oil. All these opened the door for a likely hike in June.

Most Fed officials sought signs of economic improvement in the second quarter including a strong employment and inflation scenario. Inflation rose at the quickest clip in three years in April, as the consumer price index jumped a seasonally adjusted 0.4% (read: TIPS ETF (TIP) Hits New 52-Week High).

Upbeat Data Points

Though April’s non-farm payroll reading of 160,000 was below the estimated 205,000 and the prior-month reading of 208,000, the unemployment rate was unchanged at 5%. Other key indicators including workweek and average hourly earnings showed increases. Hourly earnings in April rose 0.3% month over month and 2.5% year over year.

Meanwhile, overall retail sales expanded 1.3% in April from March, representing the largest gain since March 2015. April retail sales beat economists’ forecast of a 0.8% rise. The University of Michigan indicated that its consumer sentiment index rose 6.8 points to 95.8 in early May, marking the strongest reading since June (read: Retail Sales Back to Health; ETFs to Watch).

Since consumer spending makes up about 70% of the U.S. GDP, April retail sales data indicates that the U.S. economy is progressing at a decent clip to end Q2 and is less likely to falter like it did in Q1. In the first quarter, the economy grew at an annual rate of just 0.5%, marking a two-year low.
The housing market is also giving bullish signals. Lately, the economy was gifted with strong new home construction and building permits data (read: Homebuilder ETFs to Buy on Upbeat Data).

All these might encourage the Fed to take the next policy tightening decision sooner than expected. The last hike was seen in December 2015.

Investors’ Perception

Following the release of the minutes, investors’ bet over the possibility of a June hike shot up to 34% from 19% (according to CME Group) as indicated by the prices for futures contracts on the Fed's benchmark overnight lending rate. And by late Wednesday, traders wagered on a 56% possibility of a hike by July, up from 20% on Tuesday.

Possible ETF Moves

Some subtle moves in various markets and asset classes are likely to be observed if the Fed goes hawkish in June or July. Below we discuss a few ETFs that were among the biggest movers and could remain in focus ahead.

PowerShares DB US Dollar Bullish Fund (UUP)

As widely expected, the U.S. dollar will likely gain strength. The U.S. dollar ETF UUP was up about 0.7% on May 18.

iShares 7-10 Year Treasury Bond (IEF)

The yield on the 10-year U.S. Treasury jumped 11 bps to 1.87% on May 18, following the Fed minutes. The ultra-popular bond ETF IEF shed over 0.8%. But since global growth worries are still extensive with Brexit fears looming large, the intermediate and long-term U.S. Treasury bonds should be in fine fettle.

SPDR S&P Regional Banking ETF (KRE)
Banking stocks should rally if the Fed hikes in June as these perform better in a rising rate environment. KRE added 4.24% on May 18, 2016.
PowerShares FTSE RAFI Emerging Markets ETF (PXH)

Emerging markets ETFs will likely be losers if the Fed goes ahead with a hike. Dearth of cheap money inflows would hit this space. PXH was down about 1.4% on May 18.

iShares Select Dividend ETF (DVY)

The dividend ETFs, one of the biggest beneficiaries of subdued Treasury yields, might stall a bit if the Fed hikes sooner than expected. However, it all depends on how the global market shapes up and investors’ appetite for risk (read: 5 Global High Dividend ETFs Under $25 in Focus).

Vanguard Total Stock Market ETF (VTI)

Normally, the initial reaction of a rate hike is a slide in stock prices. However, the reaction should vary across capitalization and the turbulence should settle down with time. Total stock market ETF was down 0.01% on May 18, and may be under pressure immediately after the tightening move.

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ISHARS-7-10YTB (IEF): ETF Research Reports
PWRSH-DB US$ BU (UUP): ETF Research Reports
ISHARS-SEL DIV (DVY): ETF Research Reports
VIPERS-TOT STK (VTI): ETF Research Reports
PWRSH-F/R EMP (PXH): ETF Research Reports
SPDR-KBW REG BK (KRE): ETF Research Reports
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