ETF Strategies To Play The 7-Year High Benchmark Yield

One thing has been more or less constant this year, i.e., rising rate concerns. Higher inflationary expectations and upbeat economic growth have already driven the benchmark treasury yields to 3% that went on to score even higher on May 15 to touch the highest level in seven years at 3.08%.

A strong retail sales report led to the recent spike in bond yields. Plus, San Francisco Fed President John Williams’ comment that he sees three or four rate hikes in 2018 as the "right direction" drove bond yields.

Also, trade tensions between the United States and China is remain. If the countries fail to come to a pact, a full-blown trade conflict is likely to drive prices and in turn inflation. If this was not enough, a member of the ECB’s governing council recently commented that the conclusion of its asset purchases is imminent.

A senior U.S. economist for Capital Economics believes that the ongoing consumption growth is enough to push overall GDP growth up to more than 3% annualized. All these will give the Fed enough confidence to hike rates faster, in fact, in as soon as June. Traders have priced in a 100% chance of a June rate hike and 54% chance of three more U.S. rate hikes this year. Notable, the Fed enacted a 25-bp hike in March.

Rising yields will cause selloffs in both equity and bond markets. SPDR S&P 500 ETF (NYSE:SPY) (AX:SPY) (down 0.7%), SPDR Dow Jones Industrial Average ETF (V:DIA) (down 0.8%), PowerShares QQQ ETF QQQ (down 1.1%) and iShares 20+ Year Treasury Bond (NASDAQ:TLT) ETF (V:TLT) (down more than 1.1%) — all lost value on May 15.

Given this, investors should be interested in knowing the ETF strategies to tide over an abrupt pickup in benchmark interest rates. We have highlighted a few investing tricks for such investors.

Bet on Banks

Financial stocks are direct beneficiaries of a rise in long-term bond yields or steepening in the yield curve, which is the case now. Since banks borrow money at short-term rates and lend the capital at long-term rates, the latest spike in long-term bond yields bode well for bank ETFs.

So, ETFs like KBW Regional Banking Portfolio (NYSE:KB) , SPDR S&P Regional Banking (MX:KRE) ETF (CO:KRE) , S&P Bank ETF SPDR (NYSE:KB) E) and Nasdaq Bank ETF FT FTXO should be on one’s radar right now.

Go Short on Rate-Sensitive Sectors

Needless to say, sectors that perform well in a low interest rate environment and offer higher yield may weaken when rates rise. Since real estate and utilities are such sectors, it is better to go for inverse REIT or utility ETFs. ProShares UltraShort Real Estate (AX:SRS) , ProShares Short Real Estate REK and ProShares UltraShort Utilities (LON:SDP) are such inverse ETFs that could be wining bets in a rising rate environment (read: Rate Hike Bet Put These Inverse Sector ETFs in Focus).

Look Out for Floating Rate Bonds

Floating rate notes are investment grade bonds that do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of the issuers. Since the coupons of these bonds are adjusted periodically, they are less sensitive to an increase in rates compared to traditional bonds. iShares Floating Rate Bond FLOT is thus a great choice now (read: Hedge Rising Rates with Floating Rate ETFs).

Hoard Up on Inverse Bond ETFs

Shorting U.S. treasuries are also a great option in such times. Barclays (LON:BARC) Inverse US Treasury Aggregate ETN (CM:TAPR) , Ultrapro Short 20+ Year Treasury ProShares TTT, iPath US Treasury Long Bond Bear ETN DLBS and iPath US Treasury 10-Year Bear ETN DTYS are some of the trusted bets right now.

Target Negative Duration Bonds

Negative duration bond ETFs offer exposure to traditional bonds while at the same time short Treasury bonds using derivatives such as interest-rate swaps, interest-rate options and Treasury futures to lower interest rate risk. WisdomTree Barclays Negative Duration U.S. Aggregate Bond Fund AGND and WisdomTree Negative Duration High Yield Bond Fund HYND are examples of such funds.

Play Private Equity ETFs

As bond yields have started to rise, investors now need to focus on stable bets that offer way higher than the benchmark yield. For this, the private equity ETF pack is an option.

Investors should note that this asset class is high dividend paying in nature. PowerShares Global Listed Private Equity ETF (HN:PSP) yields about 11.83% annually. Private equity has a low correlation to the broader market.

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