Fed Meeting Influences ETF Traders' Short-Selling Decisions

The Federal Reserve holds one of its most widely anticipated meetings in recent memory on Wednesday December 16 and while there is no such thing as a sure thing in financial markets, it would be surprising if the central bank does not proceed with its first rate hike in nine years this week.

In advance of the Fed meeting and what some market observers anticipate as being the first of as many as four rate hikes next year, borrow data for some marquee exchange-traded funds indicate professional traders of exchange-traded funds are banking on the Fed moving forward with higher rates.

Related Link: What Leveraged Financial Services ETFs Are Saying About The Fed

In a new research note by S3 Partners Managing Director of Research Ihor Dusaniwsky, data suggest the “FOMC decision has influenced ETF borrow flows as the more rate sensitive ETF’s, such as large caps, high yield bonds, energy and real estate have all seen significant borrow inflows.”

S3 Partners is a financial analytics company that provides data, analytics and services to asset managers and financial intermediaries.

Short Sellers React In Anticipation

In recent days, short sellers have borrowed $1.5 billion worth of shares in the SPDR S&P 500 ETF Trust SPY, the world's largest ETF, as well as $500 billion worth of shares in one of SPY's primary rivals, the iShares S&P 500 Index (ETF) IVV, according to S3 data.

Interestingly, the data also reveal $1.3 billion in new borrows to short sellers in the iShares MSCI EAFE Index Fund (ETF) EFA. That scenario is interesting because a Fed rate hike would underscore the notion of diverging developed market monetary policies seemingly making EFA, which allocates a significant percentage of its weight to accommodative monetary policy destinations such as the eurozone and Japan, attractive in the wake of higher U.S. rates.

The S3 data also show new borrows by short sellers in the Energy Select Sector SPDR (ETF) XLE jumped by $250 million last week. In the case of increasing shorts in XLE, the largest equity-based energy ETF, this either means traders expect more downside for oil or they don't expect history to repeat— history being that XLE was by far the best performer among the nine sector SPDR ETFs during the Fed's 2004 through 2006 tightening cycle.

Related Link: Ahead Of The Fed: Interest Rates And Your Mortgage

Covered Shorts

S3's data also showed some surprises, including $900 million worth of returned shares (meaning covered shorts) in the iShares MSCI Emerging Markets Indx (ETF) EEM, the second-largest emerging markets ETF by assets. Short sellers also returned $150 million worth of SPDR Gold Trust (ETF) GLD, an ETF that has already been devastated by rising Treasury yields last week.

Perhaps the real surprise is that the Utilities SPDR (ETF) XLU and rival utilities ETF did not see significant increases in borrows by short sellers last week. Among equity ETFs, utilities are the more negatively correlated to higher Treasury yields.