Inflation concerns remained elevated at the Fed's meeting last month, as policymakers signaled that broadening price pressures could warrant additional interest rate hikes. According to Reuters, minutes from the June meeting showed that a few participants believed there was already a compelling case for increasing borrowing costs, although they ultimately agreed with the broader committee to keep interest rates unchanged at that meeting.
As quoted on the abovementioned article, per Jeffrey Roach, LPL Financial’s chief economist, the minutes show considerable uncertainty surrounding the Fed's policy outlook, highlighting differing views among policymakers.
Roach stated that the discussion suggests the committee is evaluating multiple economic scenarios before committing to its next move, rather than signaling a clear policy. While geopolitical developments in the Middle East remain an important source of uncertainty that could influence inflation and broader economic conditions, the Fed emphasized that future policy decisions will ultimately depend on incoming economic data and how risks evolve.
Uncertainty surrounding the Middle East conflict remains a key risk to the Fed's policy outlook. A prolonged disruption to vessel traffic through the Strait of Hormuz could keep oil prices elevated, adding to inflationary pressures and increasing the likelihood that inflation remains above the Fed's target.
How Likely Is Another Fed Rate Hike?
According to the CME FedWatch tool, markets expect a 62.2% likelihood of the Fed hiking rates in September. The probability of rates being increased to 3.75-4.0% at the September meeting has surged to 50.5%, compared with only 33.5% a month earlier, while the likelihood of the Fed keeping the rates unchanged has fallen to 37.8% from 61.7% in the same period.
Similarly, in October, markets forecast a 70.3% likelihood of the Fed hiking the rates. Markets are anticipating a 47.3% likelihood of interest rates being increased to 3.75-4.0% in the October meeting, up from a 39.1% likelihood just a month earlier. There is a 20.4% likelihood of the rate being hiked to 4-4.25%, rising significantly from a 9.2% likelihood just a month earlier, per the CME FedWatch tool.
In December, markets estimate an 81.6% likelihood of the Fed hiking the rates. Per the CME FedWatch tool, the probability of rates being increased to 4-4.25% at the December meeting has surged to 30.6%, compared with only 19.8% a month earlier.
However, it is worth noting that while markets have scaled back their expectations for additional Fed rate hikes over the past week, expectations remain elevated compared with a month ago. As such, investors should focus on the risk of any unexpected hawkish moves by the Fed.
ETFs to Consider
Although financial markets have likely already priced in the prospect of additional Fed rate hikes this year, uncertainty surrounding the policy outlook remains. The minutes from the Fed’s June meeting reinforced that future rate decisions will remain data dependent, while heightened uncertainty stemming from the Middle East conflict adds another layer of risk to the outlook.
Given these uncertainties, maintaining or increasing exposure to these ETFs could help protect portfolios if the Fed delivers more rate hikes than markets currently expect.
Value ETFs
Characterized by solid fundamentals, such as earnings, dividends, book value and cash flow, these stocks trade below their intrinsic value, representing undervaluation. Their attractive valuations and relatively lower volatility make value ETFs a suitable defensive holding for long-term investors.
Vanguard Value ETF VTV and iShares S&P 500 Value ETF IVE could be appealing options.
Consumer Staples ETFs
Increasing exposure to consumer staple funds can bring balance and stability to investors’ portfolios. Investors can allocate more money to consumer staple funds to safeguard themselves against potential market downturns.
Investors should consider Consumer Staples Select Sector SPDR Fund XLP and iShares U.S. Consumer Staples ETF IYK.
Inverse Gold ETFs
The prospect of a hawkish Fed and interest rates remaining higher for longer remains a key headwind for non-yielding assets such as gold. The price of the yellow metal is down about 0.55% over the past five trading sessions and 3.60% over the past month. Gold prices are also down around 5.16% year to date.
As such, investors can consider increasing exposure to inverse gold ETFs like ProShares UltraShort Gold GLL.
Bullish U.S. Dollar ETFs
The value of the greenback is closely related to the Fed’s monetary policies. The greenback's value tends to move inversely with interest rate adjustments by the Fed. Expectations of a more hawkish Fed stance make the greenback stronger.
The U.S. Dollar Index (DXY) has gained 0.87% over the past month and 2.69% year to date. As such, investors can consider increasing exposure to ETFs positioned to benefit from a strengthening dollar.
Investors can consider Invesco DB US Dollar Index Bullish Fund UUP and WisdomTree Bloomberg U.S. Dollar Bullish Fund USDU.
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State Street Consumer Staples Select Sector SPDR ETF (XLP): ETF Research Reports
Invesco DB US Dollar Index Bullish ETF (UUP): ETF Research Reports
Vanguard Value Index Fund ETF Shares (VTV): ETF Research Reports
WisdomTree Bloomberg U.S. Dollar Bullish ETF (USDU): ETF Research Reports
iShares U.S. Consumer Staples ETF (IYK): ETF Research Reports
iShares S&P 500 Value ETF (IVE): ETF Research Reports
This article originally published on Zacks Investment Research (zacks.com).