4 Investments That Could Make Sense If the Federal Reserve Raises Interest Rates
After the Federal Reserve recently decided to raise interest rates to cool an uptick in inflation, much of Wall Street and Main Street are trying to understand what its next move will be.
According to a recent CNBC article, the chances of a rate hike at the next Federal Reserve meeting in October have fallen below 20%, thanks to a weaker-than-expected September jobs report. However, this doesn’t mean the Federal Reserve won’t continue raising rates at future meetings if the economic environment changes.
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Since several economists still believe additional rate hikes are possible, now is the time to start preparing your portfolio to take advantage. Here are a few investments to consider.
1. Floating-Rate CLO ETFs
Floating-rate CLOs hold a number of corporate loans with floating-rate coupons. When the Fed Funds rate increases, these coupons are usually reset higher.
“The monthly coupons of these ETFs are generated by collateralized loan obligations whose interest is the sum of the SOFR (Secured Overnight Financing Rate) plus a margin,” said Ulrich Ebensperger, founder and CEO of Ziggma. “SOFR is roughly equal to the Fed Funds target rate give or take a few basis points. So not only do the monthly coupons rise with the Fed Rate increase, principal is also protected because of the floating rate nature of the bonds.”
Ebensperger recommended both JAAA and JBBB. JAAA will have lower credit risk because it offers AAA-rated CLO exposure. That lower risk will provide access to a 4.63% 30-day SEC yield. JBBB offers investors a higher 30-day SEC yield of 6.34%, but that comes with greater default risk. No matter the risk you want to take, these products will see higher yields if the Fed raises rates again.
2. Senior Loan ETFs
Senior loan ETFs carry some investment risk because they’re made up of bonds from companies with below-investment-grade credit. However, with additional risk comes the potential for higher returns. Similar to floating-rate CLO ETFs, the coupon rate on senior loan ETFs will increase when the benchmark rate rises.
An example is the State Street Blackstone Senior Loan ETF (SRLN). It typically holds 80% of its assets in first-lien senior secured floating-rate bank loans, offering a 30-day SEC yield of 6.78%.
3. Bank Stocks
When interest rates rise, equity investors can consider bank stocks because banks’ net interest margin, the difference between interest earned on loans and interest paid to depositors, is also increasing.
“A Fed rate hike boosts banks' net interest margin,” Ebensperger said. “This difference typically increases as the Fed rate rises because banks pass on only a fraction of higher rates to depositors. The positive effect of higher rates on earnings is somewhat mitigated by higher default rates in the face of increased lending rates.”
Investing in bank stocks still carries risk. Even though banks are earning more from mortgages, consumer loans, commercial loans and credit lines, they’re also paying more for deposits, and there can be an increased number of defaults.
4. Short-Term Treasury Bills
If you’re looking to minimize your risk, consider short-term Treasury bills, either held directly or through the iShares SGOV ETF. These have very short maturities, allowing investors to reinvest soon after interest rates rise.
Editor’s note on political coverage: MoneyLion is nonpartisan and strives to cover all aspects of the economy objectively and present balanced reports on politically focused finance stories.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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