Leveraged ETFs Are Providing Fed Clues

While you can never be certain about what the Federal Reserve will do regarding interest rates until the U.S. central bank makes a definitive announcement, there are some clues that suggest we are nearing our first rate hike of 2016.

For one, regional bank stocks and ETFs, a group that is particularly positively correlated to hawkish changes in Fed policy, are responding well to the notion of higher borrowing costs. Even with a Monday loss of nearly two percent, the largest regional bank ETF has gained 16.7 percent this month.

Not surprisingly, the Direxion Daily Regional Bank 3X Bull Shares DPST is one of the leveraged sector ETFs currently enjoying the momentum surrounding a December rate hike. Yes, DPST fell 7.6 percent Monday, reminding investors that leveraged ETFs are volatile instruments best used as a short-term trading vehicle.

Even with that Monday decline, DPST is higher by 61 percent this month, making it Direxion's best-performing leveraged bull fund on a month-to-date basis. Conversely, DPST's bearish cousin, the Direxion Daily Regional Bank 3X Bear Shares WDRW, is down 36 percent this month-to-date, making it one of the issuer's worst-performing bear funds this month.

DPST attempts to deliver triple the daily returns of the Solactive Regional Bank Index while WDRW looks to generate triple the daily inverse returns of that index. Emphasis on “daily.”

That index “utilizes each security’s free-float market capitalization to determine the largest regional banks. Once the 50 largest regional bank securities are determined, the holdings are then equal weighted. As of September 30, 2016 the Index had a median market capitalization of $3.31 billion and an average market capitalization of $5.18 billion,” according to Direxion.

Bullish regional bank ETFs are seen as prime beneficiaries of higher interest rates. Simply put, net interest margins at regional banks have been suppressed by the Fed's zero interest rate policy and reversing that policy is seen as an important catalyst in boosting profits for the banks in ETFs.

Traders are showing renewed enthusiasm for DPST and WDRW. For the five days ending Nov. 25, volume in DPST swelled to nearly 123 percent above the trailing 20-day average, according to Direxion data. Only one Direxion ETF saw a large increase in volume over the same period. WDRW's turnover nearly doubled over that five-day span, according to issuer data.