In March, the Federal Reserve decided to raise interest rates for the first time since the Covid-19 Pandemic began. The timing of the interest rate hike was needed as inflation has grown during the pandemic for many reasons. Some believe inflation is on the brink of running out of control, which has Federal Reserve members, economists, and those who work in the financial industry all making a case for more aggressive interest rate increases in the future.
With inflation above 7%, not many people would argue that interest rates need to increase in order to slow and eventually lower the inflation rate. Higher interest rates lower the number of large purchases consumers will make; think cars and homes. But high-interest rates do a similar thing to businesses; it reduces the amount they are willing to spend or reinvest in their company. These two factors together typically end up pushing the economy into a recession of some sort once and if interest rates slow the economy too much.
Tampering with interest rates is a double edge sword; you go too far in one direction, and inflation grows; too far in the other direction, and you send the economy into a recession. Unfortunately, though, we are at a point where the Fed almost has to raise rates in order to slow inflation to a more reasonable level.
Furthermore, since the market is a forward-looking entity, interest rates on homes and cars began moving higher even before the Fed's March rate hike. For example, the national average for a 30-year fixed-rate mortgage has already crept up close to the 5% mark, up from below 3% just last summer. This moves higher for the 30-year fixed-rate mortgage also came while the Fed has yet to do anything more than move the Fed discount interest rate from 0% to 0.25%. The 2-year, 5-year, 10-year, 20-year, and 30-year US Treasury bonds have also seen higher rates over the past few months. These are all indications that the market has accepted that rates are going to go higher in the future.
Lastly, from a historical perspective, in the past few years, we have experienced the lowest interest rates the US has seen in decades. In other words, the clock has swung maybe a little too far in one direction, and now it is starting to fall the other way.
So, if you believe, as I do, that interest rates will continue to go higher, and perhaps even really high, how can you make money on these moves?
First, let's take a look at a few safer options. Investors can look at a few different industries during rising interest rate environments. The most obvious are the financial sector, banks, and insurance companies. If you are interested in those, you can look at Exchange Traded Funds like the SPDR S&P Regional Banking ETF (KRE) or the SPDR S&P Insurance ETF (KIE). Banks and insurance companies typically do well in a high-interest rate environment because of how their businesses operate. Both of those ETFs invest in stocks, which may seem riskier than bonds, but really aren't during times of rising interest rates.
Another stock-based ETF worth considering is something like the ProShares Equities for Rising Rates ETF (EQRR). This ETF invests in an index of 50 US-listed large-cap stocks that are expected to perform well when interest rates are rising.
If you want to look at ETFs that don't necessarily focus on stocks, you can look at things like my favorite interest rate play, the FolioBeyond Rising Rates ETF (RISR). This ETF seeks to provide income and protect investors against rising interest rates from an investment standpoint. It is not cheap, but it has had good performance thus far in 2022, up 22% year-to-date, and based on its 10-year net-zero goal, this ETF could be a big winner this year.
Other options are the Simplify Interest rate Hedge ETF (PFIX), and the WisdomTree Interest Rate Hedged US Aggregate Bond Fund (AGZD). These two funds track bonds and either short them or are trying to produce a net zero duration bond strategy. RISR is slightly riskier than these two funds but has much better production for its investors in 2022. Something else to consider is that PFIX and AGZD also have a much lower expense ratio.
But regardless of how risky one ETF seems over the other, the biggest risk involved in investing in products that will benefit when interest rates rise is that typically rates rise slowly but fall quickly. So, you need to keep a close on these ETFs and be ready to walk away from them when and as soon as that time comes.
Disclosure: This contributor did not hold a position in any investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.