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ETFs to Benefit From Dovish Fed Signals

The Fed minutes from the November meeting confirmed that the officials expect to switch to smaller interest rate increases soon. Expectations of a less aggressive pace of U.S. monetary tightening from as soon as next month supported the stock markets, especially the ones, which were under pressure due to higher rates.  

In fact, rate-sensitive sectors such as utilities and real estate will be the biggest beneficiaries, given their sensitivity to interest rates, while gold, emerging markets and high-yield spaces will also see smooth trading. Investors seeking to tap this trend might consider Vanguard Real Estate ETF VNQ, Utilities Select Sector SPDR XLU, SPDR Gold Trust ETF GLD, iShares iBoxx $ High Yield Corporate Bond ETF HYG and iShares MSCI Emerging Markets ETF EEM.

A “substantial majority" of Fed policymakers had agreed that it would "likely soon be appropriate" to slow the pace of interest rate rises. A majority of traders now expect a 50 bps rate increase at the Fed's December meeting, following four straight 75 bps hikes. The chances of a 75 bps hike were pegged at about 34.5%.

The central bank has lifted interest rates six times so far this year with four consecutive rate hikes of 75 bps. The rate hike takes the benchmark interest rate, the federal funds rate, to 3.75-4%, its highest level since 2008. The increase in interest rates will make borrowing expensive, driving up the cost of buying a new car or house or pushing up the cost of carrying credit card debt and thus slowing down economic growth.

The dovish signal has pushed the yields down. The 10-year Treasury yield dipped to 3.659%, the lowest since Oct 5, while the 2-year yield slipped to a one-week bottom at 4.44%. A decline in yields will increase the appeal for high-yield bonds.

Additionally, the Fed minutes also weighed on the U.S. dollar, bolstering the demand for gold. This is because lower interest rates will increase the metal’s attractiveness since it does not pay interest like fixed-income assets. Further, the weakness in the dollar will help in injecting more capital into the emerging markets (read: What Lies Ahead of Dollar? ETFs in Focus).

ETFs to Benefit

Vanguard Real Estate ETF (VNQ)

Vanguard Real Estate ETF follows the MSCI US Investable Market Real Estate 25/50 Index and holds 166 stocks in its basket. Specialized REITs take the largest share at 37.4%, while residential REITs, retail REITs and industrial REITs round off the next three with double-digit exposure each. The expense ratio comes in at 0.12%.

Vanguard Real Estate ETF is the most popular and liquid ETF, with an AUM of $35.4 billion and an average daily volume of 6.2 million shares a day. VNQ has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook (read: 4 Sector ETFs to Win from October Inflation Data).

Utilities Select Sector SPDR (XLU)

With an AUM of $16.3 billion, Utilities Select Sector SPDR seeks to provide exposure to companies from the electric utility, water utility, multi-utility, independent power and renewable electricity producers, and gas utility industries. XLU follows the Utilities Select Sector Index, holding 30 stocks in its basket. Electric utilities take the top spot among sectors at 65.2%, closely followed by multi utilities (28.6%).

Utilities Select Sector SPDR charges 10 bps of annual fees and sees a heavy volume of 15.6 million shares, on average. XLU has a Zacks ETF Rank #2 (Buy) with a Medium risk outlook.

SPDR Gold Trust ETF (GLD)

SPDR Gold Trust ETF tracks the price of gold bullion measured in U.S. dollars and is kept in London under the custody of HSBC Bank USA. It is an ultra-popular gold ETF with AUM of $50.7 billion and a heavy volume of about 5.7 million shares a day.

SPDR Gold Trust ETF charges 40 bps in fees per year from investors and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook (read: Can Gold ETFs Rebound Ahead?).

iShares iBoxx $ High Yield Corporate Bond ETF (HYG)

iShares iBoxx $ High Yield Corporate Bond ETF offers exposure to a broad range of U.S. high-yield corporate bonds and tracks the Markit iBoxx USD Liquid High Yield Index. It holds 1,224 securities in the basket and charges 48 bps in fees per year from investors.

iShares iBoxx $ High Yield Corporate Bond ETF is the largest and most-liquid fund in the high-yield bond space, with AUM of $18.2 billion and an average daily volume of around 40 million shares. It has a Zacks ETF Rank #4 (Sell) with a High risk outlook.

iShares MSCI Emerging Markets ETF (EEM)

iShares MSCI Emerging Markets ETF offers exposure to large and mid-sized companies in the emerging markets and follows the MSCI Emerging Markets Index. It holds 1,242 securities, with Chinese firms making up for 29.4% of the portfolio, while India, Taiwan, and South Korea round off the next three spots with a double-digit exposure each.

iShares MSCI Emerging Markets ETF charges 68 bps of annual fees and trades in an average daily volume of 22 million shares. EEM has an AUM of $21.7 billion and a Zacks ETF Rank #4 with a Medium risk outlook.

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SPDR Gold Shares (GLD): ETF Research Reports

iShares iBoxx High Yield Corporate Bond ETF (HYG): ETF Research Reports

Vanguard Real Estate ETF (VNQ): ETF Research Reports

iShares MSCI Emerging Markets ETF (EEM): ETF Research Reports

Utilities Select Sector SPDR ETF (XLU): ETF Research Reports

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Zacks Investment Research