Three ETFs to watch on rising rates

The biggest uncertainty in the stock market over the past several months is the actual timing of the first interest rate hike in the U.S. since 2006. The Fed is on track to raise interest rates later in the year given the strengthening domestic economy and better job prospects.

In the latest FOMC meeting, Janet Yellen highlighted the procedure for rate-setting policies in the coming months. First, the Fed will remove the word ‘patient’ from its statement in describing its approach to rate hikes, and then raise interest rates when warranted at any meeting. This suggests a possible mid-year rate increase while at the same time provides flexibility to the Fed to wait longer if the labor market falters or inflation does not pick up.

The latest job data for February suggests sooner-than-expected rate hikes. This is especially true as the economy added 295,000 jobs in February, far above the market expectation of 235,000 and sustained the pace of hiring of over 200,000 jobs for the 12th month in a row. Notably, 2014 was the best year for job growth since the late 1990s.

Unemployment dropped to 5.5%, the lowest rate since May 2008. Average hourly wages of $24.78 rose modestly  by 3 cents in February and 48 cents over the past 12 months. The solid job data fueled expectations that unemployment would fall further and inflation might pick up. In anticipation, interest rates have been inching up. The yield on the 10-year Treasury bond has risen 33% in the past five weeks (ending March 6), representing the sharpest 5-week increase in 20 years.

While investors are dumping long-duration bonds and bond funds, there are still a number of compelling choices in the fixed income ETF world in this rising rate environment. Some of these are senior loan funds, floating rate funds, and zero or negative duration bond funds. Below, we have detailed one ETF from each category that investors should keep a close eye on and its holdings:

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