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The Bank of Canada (BoC) kept the benchmark interest rate at 0.25% at its December 8 meeting. Inflation in Canada hit an 18-year high at the end of 2021. Pressure is on central banks to push back this trend which is putting pressure on consumers. Bettors expect the BoC to pursue several rate hikes in 2022. Today, I want to take a look at two exchange-traded funds (ETFs) that will be well positioned in a tightening rate environment. Additionally, I want to look at an ETF that is also worth avoiding in this climate. Let’s go.
Here’s why banks are a great target when interest rates rise
In November, I suggested investors target financial-focused ETFs as we prepare for a rate tightening. Investors may consider BMO Equal Weight Banks ETF (TSX: ZEB) before the new year. This ETF provides exposure to major Canadian banks. Its shares climbed 31% in 2021 in the early afternoon of December 8. It is weighted equally to mitigate risk.
Canadian banks have expanded their loan portfolios in a favorable credit environment. Higher rates will put pressure on credit growth, but will also lead to improved profit margins for Canada’s major financial institutions. This ETF has a strong MER of 0.28%. Investors will be familiar with the main holdings of the account, which include TD Bank, Scotiabank, and Bank of Montreal in the first three most important weightings. Its shares fell 1.2% in a month-to-month period.
Commodity-focused ETFs can be dangerous when rates rise
Commodities flourished in 2021 as the improving global economy led to increased demand. The oil and gas sector has performed particularly well over the past year. Rising interest rates have historically exerted pressure on commodity prices. Investors may want to avoid ETFs like iShares S & P / TSX Capped Energy ETF (TSX: XEG) as we look to the New Year.
The shares of this ETF jumped 80% in 2021 in the wake of the energy recovery. A rate tightening could torpedo the momentum that has built up in this space. Investors may want to consider taking profits on oil and gas assets as we prepare for rate hikes.
Why I am considering this ETF in the event of a rate hike in 2022
Bond funds are another attractive target in the run-up to a possible rate tightening cycle. These ETFs can also provide hedge against a volatile stock market that could emerge as interest rates rise. BMO Ultra Short Term Bond ETF (TSX: ZST) is designed to provide exposure to a diversified mix of short-term fixed income asset classes. It also has a low MER of 0.15%.
This ETF has fallen 1.9% in 2021 as of this writing. Investors should consider targeting this ETF before the New Year. It can bring stability and steady gains as central banks seek to fight inflation.