Fed Rate Hike Possibility Shifts Investor Exposure Toward Financials

Investors may need to avoid stocks of companies that borrow heavily, especially real estate investment trusts, and overweight financial stocks. Financial stocks see an increase in their net interest margins—the difference between what they earn on loans and pay on deposits—when rates rise. This shift in exposure is a response to the possibility that the Federal Reserve may raise benchmark interest rates this year. Cleveland Federal Reserve President Beth Hammack stated a rate hike is possible if inflation stays persistently above target. Chicago Fed President Austan Goolsbee said rate increases must be on the table if inflation ticks up. Minutes from the January meeting show 19 rate-setting committee officials wanted the Fed's statement to reflect the possibility of hikes. Risk assets like stocks tend to fare poorly when the Fed raises rates to tighten the money supply. The current yield of the two-year Treasury note is trading above the effective Fed funds rate, suggesting bond traders expect a higher rate in the near future.