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The latest rounds of strong economic data and prevalent inflation has put a steeper-than-expected rate hike back on the table. Fed Chair Jerome Powell turned hawkish during his testimony to the Senate Banking Committee and opened the door to a half-point rate hike in March.

Given this, investors should focus on areas/sectors that will benefit the most from the Fed’s rate hike action. ETFs like Financial Select Sector SPDR Fund (XLF - Free Report), Invesco S&P SmallCap Industrials ETF (PSCI - Free Report), Vanguard Consumer Discretionary ETF (VCR - Free Report), and iShares Core S&P U.S. Value ETF (IUSV - Free Report) from different corners of the market seem compelling picks. These funds have a Zacks ETF Rank #1 (Strong Buy) or 2 (Buy), suggesting their outperformance in the months to come.

Fed Chair Jerome Powell warned that the central bank would likely raise its key interest rate higher than anticipated and could resume larger hikes, citing a recent surge in job growth and inflation after slowing the pace in recent months. According to the CME FedWatch Tool, investors are now betting that the Fed could raise rates by 50 bps later this month. Some 78% of traders are bracing for a steeper rate hike later this month, up from just 29% one week ago.

Goldman Sachs raised its forecast for peak Federal Reserve rates to 5.5-5.75% following the hawkish testimony by Jerome Powell that opened the door to a half percentage-point increase later this month. Meanwhile, a key recession indicator flashed its loudest warning ever. The inversion between the 2-year and 10-year Treasury yields hit a record 103.5 basis points on Mar 7, according to Refinitiv data.

Higher interest rates usually indicate a healthy economy, thereby benefiting cyclical sectors like financial, industrial, and consumer discretionary. Banks are in the most advantageous position as they seek to borrow money at short-term rates and lend at long-term rates. If interest rates rise, banks would earn more on lending and pay less on deposits. This would expand net margins and bolster banks’ profits. Also, insurance companies will be able to earn higher returns on their investment portfolio of longer-duration bonds.

An improving economy coupled with higher consumer confidence will also make the consumer discretionary sector tempt investors amid higher yields. Additionally, higher interest rates lead to greater consumer power and increased IT spending. This combination of factors will result in increased industrial activity and a pickup in consumer demand, thereby lifting value stocks.
 

ETFs to Win

Financial Select Sector SPDR Fund (XLF - Free Report)

The ultra-popular Financial Select Sector SPDR Fund ETF seeks to provide exposure to 67 companies in diversified financial services, insurance, banks, capital markets, mortgage real estate investment trusts, consumer finance, and thrifts and mortgage finance industries. It follows the Financial Select Sector Index, charging investors 10 bps in fees per year.

Financial Select Sector SPDR Fund has an AUM of $33.7 billion and trades in an average daily volume of 37.5 million shares. It carries a Zacks ETF Rank #1 with a Medium risk outlook.

Invesco S&P SmallCap Industrials ETF (PSCI - Free Report)

Invesco S&P SmallCap Industrials ETF offers exposure to small-cap companies that are principally engaged in the business of providing industrial products and services, including engineering, heavy machinery, construction, electrical equipment, aerospace and defense, and general manufacturing. It holds 91 stocks in its basket, with key holdings in machinery, commercial services & supplies, and building products.

Invesco S&P SmallCap Industrials ETF has amassed $80.8 million in its asset base and charges 29 bps in annual fees. It trades in a volume of 3,000 shares and has a Zacks ETF Rank #2 with a High-risk outlook.

Vanguard Consumer Discretionary ETF (VCR - Free Report)

Vanguard Consumer Discretionary ETF follows the MSCI U.S. Investable Market Consumer Discretionary 25/50 Index and holds 308 stocks in its basket. In terms of industrial exposure, Internet & direct marketing retail and automobile manufacturers occupy the top spots with double-digit exposure each.

Vanguard Consumer Discretionary ETF is the low-cost choice in the space, charging investors only 10 bps in annual fees while volume is good at nearly 93,000 shares a day. The fund has managed $4.1 billion in its asset base and has a Zacks ETF Rank #1 with a Medium risk outlook.

iShares Core S&P U.S. Value ETF (IUSV - Free Report)

iShares Core S&P U.S. Value ETF offers exposure to large- and mid-cap U.S. equities that exhibit value characteristics by tracking the S&P 900 Value Index. It holds 707 stocks in its basket, with each accounting for no more than 4.7% share. iShares Core S&P U.S. Value ETF is widely spread across sectors, with financials, information technology, industrials, and consumer discretionary occupying double-digit exposure each.

iShares Core S&P U.S. Value ETF has an AUM of $13.2 billion and trades in an average daily volume of 733,000 shares. It charges 4 bps in annual fees and has a Zacks ETF Rank #2 with a Medium risk outlook.

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