ETFs To Benefit Or Lose From Rising Yields

Treasury yields have been on the rise in recent weeks with the 10-year yield approaching to the 3% level. Crossing this threshold could trigger financial shock waves as it did in 2013. Notably, the 10-year Treasury yields hit its highest level since January 2014 at 2.99% on Apr 23, pushing the gap (or spread) to German bonds the widest in 29 years.

A recent spike in commodity prices, especially oil and metals, has lifted inflation expectations, which in turn is fueling speculation of four rate hikes this year. Per the latest CME's FedWatch tracking tool, the market is projecting 50% chances of a total of four interest rate hikes this year. This compares to 33% probability a month ago and less than 40% late last week.

Pros and Cons

A rising rate environment is highly beneficial for cyclical sectors like financial, technology, industrials, and consumer discretionary. In particular, banks are at 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 be able to earn more on lending and pay less on deposits. This would expand net margins and bolster banks’ profits. Also, insurance companies are able to earn higher returns on their investment portfolio of longer-duration bonds.

Higher rates would attract more capital to the country from foreign investors, thereby boosting the U.S. dollar against the basket of other currencies. However, this would have a huge impact on commodity-linked investments, reflecting that a rising rate environment will hurt a number of segments. In particular, high dividend paying sectors such as utilities and real estate would be the worst hit given their higher sensitivity to rising interest rates. Additionally, securities in capital-intensive sectors like telecom would also be impacted by higher rates.

Further, higher rates would also result in tighter lending conditions and curtail consumer spending on a wide range of products like cars and houses. This will in turn lower profitability across various segments.

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Disclosure: contains statements and statistics that have been obtained from sources believed to be reliable but are not guaranteed as to accuracy or completeness. References to any specific ...

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