While many expect the Federal Reserve to push off on a rate hike, there is still a chance of a higher interest rate announcement next week. The change will have wide reaching effects and weigh on many markets and exchange traded funds.
The markets currently predict a one in four chance that the Federal Open Market Committee meeting will announce tighter rates on September 17, reports John Authers for the Financial Times.
Nevertheless, ETF investors can utilize bearish or inverse options to hedge against potential risks.
Specifically, higher interest rates will have an effect on commodities and currencies. A tighter monetary policy will directly strengthen the U.S. dollar, which would pressure assets priced in dollars.
Investors can track the stronger dollar with the PowerShares DB U.S. Dollar Index Bullish Fund (NYSEArca: UUP) or the actively managed WisdomTree Bloomberg U.S. Dollar Bullish Fund (NYSEArca: USDU).
On the other hand, a strong dollar would weigh on commodities. ETF investors can hedge against weakness in the commodities space with the DB Commodity Short ETN (NYSEArca: DDP), which takes the simple short position on a group of diversified commodities, and the DB Commodity Double Short ETN (NYSEArca: DEE), which takes the two times the inverse position on a basket of commodities. Additionally, the ProShares UltraShort Bloomberg Commodity (NYSEArca: CMD) also takes the daily -2x or -200% performance of the Bloomberg Commodity Index.
A stronger dollar and rising interest rates are also seen as deflationary, which would weigh on gold prices as well. Consequently, traders who want to hedge any downside risk in gold can utilize inverse or short gold ETF options. For example, the ProShares UltraShort Gold (NYSEArca: GLL) provides a two times inverse, or -200%, daily performance of gold bullion. The Direxion Daily Gold Bear 3X Shares (NYSEArca: BARS) reflects the daily -300% daily performance of gold. Alternatively, ETN options include the PowerShares DB Gold Double Short ETN (NYSEArca: DZZ), which tries to generate the twice inverse, or -200%, return of the daily performance of gold, PowerShares DB Gold Short ETN (NYSEArca: DGZ), which tries to reflect the inverse of gold price movements, and VelocityShares 3x Inverse Gold ETN (NYSEArca: DGLD), which tries to reflect the performance of three times the inverse, or -300%, daily performance.
The stronger dollar and higher U.S. rates will also fuel further outflows from the emerging markets, especially those with large current account deficits, like Brazil. Investors seeking to hedge or even aggressively position on emerging market weakness can take a look at inverse ETFs, including ProShares Short MSCI Emerging Markets (NYSEArca: EUM), ProShares UltraShort MSCI Emerging Markets (NYSEArca: EEV) and Direxion Daily Emerging Markets Bear 3x Shares (NYSEArca: EDZ). Traders can also capitalize on the weakness in Brazil through the ProShares UltraShort MSCI Brazil Capped (NYSEArca: BZQ), which takes the -2x or -200% daily performance of the MSCI Brazil 25/50 Index.
Higher interest rates will also push bond yields highers and weigh on bond prices, especially on long-duration assets. Amid fears that the Federal Reserve is inching closer to raising interest rates, investors have turned to bearish long-term bond ETFs, such as the ProShares UltraShort 20+ Year Treasury (NYSEArca: TBT), Direxion Daily 20-Year Treasury Bear 3X (NYSEArca: TMV), ProShares Short 20+ Year Treasury (NYSEArca: TBF).
Leveraged ETFs have also helped investors juice market returns. However, people should not blindly add these types of products into a portfolio without fully understanding how the investments work. These geared products try to generate the multiple returns of a given market by taking on leverage through derivatives instruments and come with significant risks. [Do You Know How Your Leveraged ETFs Work?]
For more information on bearish fund products, visit our inverse ETFs category.
Max Chen contributed to this article.