Given the trajectory of the U.S. economy, the Federal Reserve may hike rates sooner than anticipated, strengthening U.S. dollar exchange traded funds but weighing on short-term Treasury bonds and gold.
Federal Reserve Chair Janet Yellen revealed that they will taper the asset purchase program by anther $10 billion and estimated that the Fed could hike short-term rates six months after the quantitative easing program is eased out. However, at its current pace, the Fed could raise rates by the spring of 2015, earlier than most expected, writes Russ Koesterich, Managing Director, BlackRock‘s Global Chief Investment Strategist.
If the Fed raises rates, the U.S. dollar will strengthen. The stronger dollar will be particularly noticeable as Japan continues with its aggressive easing program and the European Central Bank maintains its loose monetary policy, Koesterich added.
ETF investors can play the stronger greenback through the PowerShares DB U.S. Dollar Index Bullish Fund (NYSEArca: UUP) or an actively managed option with the recently launched WisdomTree Bloomberg U.S. Dollar Bullish Fund (NYSEArca: USDU). Additionally, for the more aggressive trader, the PowerShares DB 3x Long US Dollar Index Futures ETN (NYSEArca: UUPT) provides a leveraged 300% bullish monthly return to the U.S. dollar futures index. [U.S. Dollar ETFs to Ride the Shift in Fed Policy]
On the other hand, rising rates will pressure fixed-income assets – bond prices have an inverse relationship to interest rates, so rising rates translates to falling prices. Specifically, will see a more immediate effect in Treasuries.
“Echoing a point we have been making for the past several months, the short and intermediate portions of the Treasury market (Treasury bonds with durations of three to seven years—the area often called the “belly” of the yield curve) could be particularly vulnerable to increased volatility, and are the areas most likely to be hurt by an increase in rates,” Koesterich said.
For instance, short- and medium-duration Treasuries like the iShares 1-3 Year Treasury Bond ETF (NYSEArca: SHY), iShares 3-7 Year Treasury Bond ETF (NYSEArca: IEI) and iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) could see greater swings. Over the past week, SHY dipped 0.2%, IEI declined 0.6% and IEF fell 0.4%.
However, short-term geopolitical tensions between Russia and Ukraine could help prop up Treasuries as a safe-have play.
Additionally, a stronger U.S. dollar will diminish overseas demand for gold and rising real rates will put pressure on gold as an inflationary hedge. The SPDR Gold Shares (NYSEArca: GLD) has declined 4.2% over the past week. [ETF Chart of the Day: Gold Medals]
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Max Chen contributed to this article.