How To Make A Conservative Bet On The Fed Raising Rates

It is no secret that the Federal Reserve commences its two-day meeting Wednesday with one of the most widely anticipated interest rate announcements in recent memory slated for Thursday.

When it comes to how traders are viewing what that decision will be, Fed funds futures recently indicated that fewer than a third of fixed income traders are wagering the Fed will boost borrowing costs. However, there also is not a dearth of market observers that believe it is foregone conclusion the U.S. central bank will pass on raising rates.

But not all are convinced the Fed wont move rates. JPMorgan Chase Chief U.S. Economist, Michael Feroli thinks the odds of the Fed making the move may be slightly higher. In fact, he thinks the Fed should hike rates, but communicate that its the pace, notthe timing of the hike that matters. UBSs Chief Economist, Drew Matus wrote that he estimates theres a 60% chance the Fed hikes this week, said Direxion in a recent note.

Related Link: Fed Watch: It's Judgment Day

Traders have myriad options within the world of exchange traded funds for betting on higher interest rates, including familiar fare such as the ProShares UltraShort 20+ Year Treasury (NYSE:TBT) and the Direxion Daily 20-Year Treasury Bear 3X Shares (NYSE:TMV). As the names of those funds imply, they are bearish bets against longer-dated Treasurys.

Traders looking to establish a bearish view on the broader bond market can turn to the Direxion Daily Total Bond Market Bear 1X Shares (NYSE:SAGG). The aptly-tickered SAGG is not a leveraged ETF. It is designed to deliver the daily inverse performance of the Barclays US Aggregate Bond Index on a percent-for-percent basis. So if the Barclays US Aggregate Bond Index falls by 1 percent on a particular day, SAGG should rise by 1 percent.

The Barclays US Aggregate Bond Index allocates over 65 percent of its combined to Treasurys and mortgage-backed securities, making SAGG a potentially profitable bet on hawkish Fed action this week and one that merits immediate consideration.

Some market observers believe September is an ideal time to raise interest rates because, It offers a compromise between hawks and doves, getting one rate hike 'out of the way' without committing the Fed to more. It provides optionality for those who anticipate that more than one hike this year would likely be appropriate (10 FOMC members, or the majority of the committee, as of June, though likely there are now a few less). It avoids any risks resulting from policy changes around year-end, when bank funding issues tend to become more complex, said UBS's Matus, according to Direxion.

And for those betting a September rate increase marks the start of a lengthy tightening cycle, SAGG has another advantage: It charges just 0.65 percent per year, which is low among inverse and geared ETFs.