Leading into “Fed Day” on Wednesday, some market observers had suggested the Federal Reserve wouldn’t raise interest rates, in order to avoid adding even more volatility to markets following the bank crisis drama. The Fed raised them anyway. For this week’s watercooler conversation, the VettaFi Voices assess the impact of yet more Fed rate hikes, and what it all might mean for bond and equity risk.
Todd Rosenbluth, director of ETF research: I think many investors thought a 25 basis point hike was likely, although some might have hoped the Fed would pause, given the banking crisis that is still an issue. But the lack of confidence on the Fed’s next moves is evident. The Fed does not expect to cut rates at all for the rest of 2023, but the market was still expecting it as of Wednesday. I think the iShares 20+ Year Treasury Bond ETF (TLT) is a good indication of this. This is one of the most interest rate sensitive ETFs around, with a duration of 18 years. TLT rose on Wednesday, climbing even higher after the Fed announcement and Powell’s press conference, only to give all those gains back, as of 11:30 AM Thursday.
On a recent webcast, advisors told us they saw the greatest investment opportunities in fixed rate, short term Treasury bond ETFs: funds like the Vanguard Short-Term Treasury ETF (VGSH), and the iShares 1-3 Year Treasury Bond ETF (SHY), as well as floating rate ETFs like the WisdomTree Floating Rate Treasury Fund (USFR), because of the relative safety and compelling yields. USFR has pulled in $1.6 billion in the past month and over $440 million in the last week; it’s becoming one of the go-to vehicles for short-term Treasury exposure.
Meanwhile, we are seeing some increased interest in high yield bond ETFs, which don’t have the same level of interest rate risk but sport 8% yields. The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and the SPDR Bloomberg High Yield Bond ETF (JNK) have seen inflows in the past week and engagement for high yield on VettaFi platforms is higher than it was a month earlier.
Within equities, growth ETFs like the Invesco QQQ Trust (QQQ) and technology ETFs like the Technology Select Sector SPDR (XLK) are the standouts. Roxanna Islam has a great piece out this week on this topic, so I will not steal her efforts.
We have seen investors turn to gold ETFs, which we talked about in last week’s “VettaFi Voices On”, as the uncertainty in the global economy and in US monetary policy has created reasons to look for tactical safe havens. The SPDR Gold Shares ETF (GLD) and the iShares Gold Trust (IAU), which are the more institutionally focused gold ETFs, have seen inflows, while the more retail friendly SPDR Gold MiniShares Trust (GLDM) has not seen much.
Stacey, how has oil been acting, and what impact does this have on MLPs?
Stacey Morris, head of energy research: The US oil benchmark has rebounded back above $70 per barrel, recovering some of its losses from last week when the banking crisis and risk-off sentiment weighed on the commodity. MLPs are less exposed to oil volatility because of their fee-based business model. As such, they held up better than other energy subsectors last week.
MLPs could be an interesting alternative to high yield bonds. To be clear, MLPs are not a proxy for fixed income, but MLPs are also yielding around 8%. As we mentioned on a webcast earlier in the week, investment-grade companies represent ~76% of the underlying index for the Alerian MLP ETF (AMLP) by weighting. Based on distributions (dividends) paid in 1Q23, approximately 92% of AMLP’s underlying index increased its payout over the last year. I remain constructive on the outlook for MLP distributions as companies continue to generate solid free cash flow.
Dave Nadig, financial futurist: I called this the banking crisis the most boring crisis ever only partially in jest, but honestly, much of this has played out according to the “common wisdom” playbook. Fed Chair Powell did, I thought, extremely well in the press conference, other than a stumble here or there in the Q&A. But what he needed to do — what the Fed needed to do — was convince people that the adults were in charge. Things were going great until Yellen spoke. Which is why I think this chart is FASCINATING:
That’s the 2-Year Treasury plotted against the SPDR S&P 500 ETF Trust (SPY). It’s a decent way of thinking about market reaction: Did the market go long equities, or run for cover? Initially, both stocks and bonds traded up: Essentially, people heard what they wanted to hear out of the gate. But over the course of the presser, Janet Yellen simultaneously contradicted Powell’s carefully constructed “banks are safe” narrative. Stocks then sold off and bonds went even higher. After which, the equity market took a LONG time compared to the bond market to (probably correctly) parse that the adults weren’t actually talking to each other.
Rosenbluth: I agree Powell showed that the Fed was on the case and even made it clear what words mattered most in the statement. But I think they still do not have a clear sense of what might happen next. That’s why the market is ahead of the Fed, last I checked.
Nadig: What does all this mean for your portfolio right now? Well, you have to pay pretty close attention and probably not make any sudden moves. Having leadership that’s more toddler than parent means more volatility. Directionally, it will probably make no difference: The U.S. isn’t going to start letting depositors lose money, and I think the market really knows it. But it’s also clear there’s huge room for improvement on messaging.
Bottom line: the commitment to getting inflation down is strong. We could argue about whether they did too much, too fast, but here we are, with a still-hawkish Fed but with pretty clear visibility to the terminal state.
Roxanna Islam, associate director of research: I think Wednesday was really interesting because even though there was a 25 bps rate hike, it wasn’t unexpected. Many investors actually took away a few positives from the meeting–mainly that the Fed removed language about “ongoing increases,” which means that interest rate hikes could be nearing an end. Many are expecting at most one more rate hike, but there’s a good amount of people out there that think this may be the last one.
Even though the Fed also stated that there won’t be any rate decreases in 2023, I still think there’s more confidence returning back to growth and tech sectors. A lot of that is in large-cap tech stocks like Microsoft (MSFT) and Apple (AAPL) along with some large-cap semiconductor stocks like Nvidia (NVDA). The Technology Select Sector SPDR Fund (XLK) was up 1.6% mid-day on Thursday, and semiconductor ETFs were up even more. The VanEck Semiconductor ETF (SMH) and the iShares Semiconductor ETF (SOXX) were both up 2.7% as of Thursday.
Semiconductor ETFs have seen a lot of interest lately, and it’s not just because they hold a lot of large-cap tech stock, like NVDA or Advanced Micro Devices (AMD). There’s a lot of interest stemming from ChatGPT and other artificial intelligence, which lately has been one of the more optimistic stories (considering all that we’ve seen recently including a banking collapse, crypto turmoil, and ongoing inflationary concerns). I actually touched on this in my note for this week.
Yet interest rate hikes affect us as consumers — and those hikes are going to make it harder for people to buy homes, cars, or put money on credit cards. That has to be considered as well, especially since consumers are basically 2/3 of the economy. So the fact that this is possibly one of the last rate hikes can provide some relief.
Rosenbluth: To Dave’s point about whether you need to do anything differently, this is an environment when active ETFs could make sense. If you don’t want to manage the duration of your fixed income allocation there are many well established active asset managers offering core bond ETF strategies including Capital Group, Franklin Templeton, JPMorgan, PIMCO, T. Rowe Price, and many others with the same macro expertise you’d expect, but in a more tax efficient, liquid product.
Nadig: I guess there’s a middle ground here, too. It’s definitely a time to pay attention, but it’s never a good idea to actively be repositioning portfolios in high-volatility, high-uncertainty markets (which is how I would describe this little window of regulators not coordinating well). For sure, this is a case where an active bond manager can really earn their stripes. But I wouldn’t recommend anyone going whole hog into a narrow corner of the bond market just because something seems cheap, or worse, shiny.
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