Investors, buckle up because the next Federal Open Market Committee (FOMC) meeting starts on Tuesday, Sept. 15, and spans into the next day. In advance of the central bank's next meeting under new Chair Kevin Warsh, Fed funds futures, which are used by professional traders to potentially capitalize on Fed decisions, imply an 87.3% chance that a rate hike is coming.
That expectation is justified because the August Consumer Price Index (CPI) reading released last week came in hotter than expected. Getting down to brass tacks, some Fed members are overt in their desire to ward off inflation, and raising interest rates is a preferred "blunt tool" of central banks to accomplish that objective.
If the Fed raises rates, this Vanguard ETF could rally. Image source: Getty Images.
Rate hikes often carry a negative connotation, but experienced investors know that some sectors actually respond well to Fed tightening, suggesting that a hawkish Fed presents opportunities for astute market participants. One way to capitalize may just be the Vanguard Energy ETF (VDE -3.44%).
Why now for this ETF?
Admittedly, the Vanguard Energy ETF, one of the largest exchange-traded funds (ETFs) focused on the energy sector, is up some 48% year-to-date. Hence, investors are right to ponder the wisdom of considering this fund now.
Fortunately, this ETF and its peers have a compelling track record. On a historical basis, rising bond yields, which would be a likely outcome of a Fed rate hike, benefit cyclical sectors, and energy is one. In fact, only bank stocks, auto components stocks, and diversified financial services names show better long-term performance in the face of rising bond yields than energy stocks do.
Obviously, bond yields rise and fall without the Fed doing anything, so investors may be wondering how this Vanguard ETF will perform if the central bank actually raises rates this week. Time will tell, but if history repeats, that'd be positive, as going back to the mid-1990s, energy, materials, and technology have been the best-performing sectors when the Fed turns hawkish.
NYSEMKT: VDE
Key Data Points
For those who want more recent history, the Vanguard Energy ETF surged 62.9% in 2022. Yes, oil prices spiked that year because Russia invaded Ukraine, but between March and December of that year, the Fed increased rates seven times.
Read the tea leaves
Two more points to consider regarding this Vanguard ETF and higher interest rates. First, if the Fed does boost rates, it will almost certainly be because of inflation. It'd be an admission that inflation is too high, potentially propelling energy stocks, which are seen as inflation hedges.
Second, the central bank likely wouldn't consider tightening if it wasn't confident in the strength of the U.S economy. Rate hikes often cool economic growth, so a rate increase could be interpreted as a vote of confidence in the economy, and that endorsement could help cyclical sectors.
The Vanguard ETF has other fine points. It allocates 36.4% of its portfolio to ExxonMobil and Chevron, making it a relevant consideration for investors who want exposure to both oil giants. And of course, this fund is inexpensive to own. Its annual fee of 0.09%, or $9 on a $10,000 investment, is well below the category average of 0.93%.
