How To Go Long On Rate Sensitive Sectors With ETFs

Worries that the coronavirus outbreak will turn into a pandemic led to free fall in the bond yields over the past several weeks. Further, the recent Fed emergency interest rate cut has pushed the yields to record low. Notably, the yields on the 10-year U.S. Treasury note dropped to below 1% for the first time ever and the yields on the 30-year note fell to 1.612%, near its lowest level. Meanwhile, two-year yields tumbled to 0.723% – its lowest since August 2016.

The Fed has slashed the interest rates by half-percentage point to the range of 1.00-1.25% to protect the longest ever economic expansion in the face of the deadly virus. This represents the first emergency rate cut and the biggest one-time cut since 2008.

A Boon

A rate cut is a boon to rate sensitive and high-yield sectors such as utilities and real estate. When interest rates decline, these sectors, which are generally known for the income they generate, gain momentum. Lower rates will push down rates on retail products, such as mortgages and bank loans. This will encourage people to buy more homes and make refinance cheaper. Further, lower interest rates will keep borrowing cost down, thereby resulting in higher consumer spending and rise in economic activities. This will, in turn, increase profitability across various segments.

In such a scenario, investors could make a short-term bullish play on the rate-sensitive sectors as these spaces will continue to trade smoothly in the wake of rate cuts or expectation of further cuts.

How to Play?

While futures or long-stock approaches are some of the possibilities, leveraged ETFs might be good options. Leveraged ETFs provide exposure that is a multiple (2 or 3 times) of the performance of the underlying sector using various investment strategies such as swaps, futures contracts, and other derivative instruments.

As most of these funds seek to attain their goal on a daily basis, their performance could vary significantly from the inverse performance of the underlying index or benchmark over a longer period when compared to a shorter period (such as, weeks, months or a year) due to the compounding effect.

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