These ETFs could be winners if the Federal Reserve skips a rate hike

Published Wed, Jun 14 202311:21 AM EDTUpdated Wed, Jun 14 202311:53 AM EDT

Jesse Pound @/in/jesse-pound @jesserpound

The June meeting of the Federal Reserve comes as investors are trying to balance worries about an economic slowdown with the fact that stocks have rallied sharply this year and appear to be gaining more steam. The central bank is widely expected to keep rates steady Wednesday. It will mark the first meeting at which the Fed has not raised its benchmark rate since starting its latest hiking cycle in March 2022. However, many Wall Street pros are expecting a "hawkish pause," in which the Fed makes clear that it is more than willing to hike again in the coming months. "They have the potential to change their projections, potentially increasing the median forecast in their dot plot to signal that there could be more rate increases, which could be a hawkish signal ... The other area that markets will be looking at very closely is the inflation forecast," said Michelle Cluver, portfolio strategist at Global X. A more clean Fed pause could be an event that investors cheer, pushing equities up and bond yields down, but the mixed messages and the recent rally for stocks could make for a rocky trading session. "Risk is very overbought near term. On the one hand, we're vulnerable to negative news [Wednesday], or perceived negative," said Andrew Slimmon, U.S. equity portfolio manager at Morgan Stanley Investment Management. "It's just hard to see the market selling off substantially when so many investors are looking for an opportunity to get back involved." Slimmon said the market is in a "progression from fear to [fear of missing out]" that should see the rally broaden out beyond tech stocks as the year progresses and investors rotate out of money market funds. The potential for short-term volatility and a long-term rally would seem to benefit funds such as the Invesco S & P 500 Equal Weight ETF (RSP) and the iShares Russell 2000 ETF (IWM) , which have seen a recent uptick in inflows and are outperforming the Nasdaq 100 in June. IWM 1M mountain Small cap stocks have rallied in June. But for investors worried that more Fed rate hikes in the coming months could tip the economy into recession, fixed income might be a more attractive bet. Jared Woodard, investment and ETF strategist at Bank of America, said in a note to clients Monday night that municipal bonds look relatively attractive among fixed income assets. "Municipal bond issuers appear well poised to weather a possible recession in 2023/24. State and local government 'rainy day' funds are at record highs of $120bn. Ratios of revenue relative to debt are also strong at 1.07, the highest since 2003," Woodard wrote. Bank of America has the equivalent of a buy rating on several municipal bond ETFs, including JPMorgan Ultra-Short Municipal Income ETF (JMST) and the iShares National Muni Bond ETF (MUB) . And with fixed income, its not just the type of bond that matters but also the timing. Cluver said her team shifted its fixed-income exposure to focus more on the "early-intermediate" duration area of the yield curve. Short-term bond funds were extremely popular last year, as they were able to capture the additional yield from Fed rate hikes, but funds focused on slightly longer-term bonds would allow investors to lock in yields now ahead of potential rate cuts down the line. "The intermediate duration portion typically does well as we reach the end of the Fed's rate hiking cycle. It is typically in the last six months we start seeing that area of the curve hold up better than the rest," Cluver said. Some large funds that could fit that description include the iShares 3-7 Year Treasury Bond ETF (IEI) , the Schwab Intermediate-Term US Treasury ETF (SCHR) and the Vanguard Intermediate-Term Corporate Bond ETF (VCIT). That is also the part of the curve targeted by a new ETF from Rick Rieder, BlackRock chief investment officer of global fixed income. The actively managed Flexible Income ETF (BINC) launched in May and has about $76 million in assets so far, according to FactSet.