As widely expected, the Fed raised interest rates for the third time in six months by a quarter percentage points and laid out plans for unwinding its $4.5 trillion balance sheet starting this year. It will likely reduce bond holdings by a maximum of $50 billion per month, or $600 billion per year. The action would lead to a rise in long-term yields, thereby dimming the appeal for long-term Treasury bonds.

However, the process will be gradual and take years to be accomplished. While the central bank stated its intention of hiking rates once more this year, lower-than-expected inflation is expected to be bullish for long-term bonds. The Fed expects inflation to stabilize but remain below its 2% target this year given rounds of weak inflation data. This move led to a decline in long-term Treasury yields to their lowest level since November.

In fact, yields on 10-Year Treasury note plummeted to 2.138%, the biggest one-day decline in about a month and 30-Year Treasury yields tumbled to 2.783%. As a result, yield curve flattened post Fed release with the spread between the yields of the 2-Year and 10-Year Treasury notes narrowed to below 80 bps, representing the tightest level since early September. It is close to a spread of 75 bps seen in July 2016 that marked the flattest level since 2007. The behavior of the yield curve justifies the bullish trend in long-term Treasuries (read: ETF Winner and Loser from a Flattening Yield Curve).

Further, the yield curve suggests that investors’ are not confident of the Fed’s ability to accomplish its planned balance sheet reductions and that its current tightening path could slow U.S. economic expansion. Given this, long-term Treasury bond ETFs deserve a closer look at least for the short term.

Vanguard Extended Duration Treasury ETF (EDV Quick QuoteEDV - Free Report)

This fund provides exposure to the long-term Treasury STRIPS market by tracking the Bloomberg Barclays U.S. Treasury STRIPS 20–30 Year Equal Par Bond Index. It holds 78 bonds in total with effective maturity of 25.0 years and average duration of 24.7 years. Expense ratio comes in at 0.07%. The product has amassed $532.9 million in its asset base while sees moderate volume of 61,000 shares per day on average. It has gained 2.2% post Fed statement.

PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (ZROZ Quick QuoteZROZ - Free Report)

This ETF follows the BofA Merrill Lynch Long Treasury Principal STRIPS Index and holds 20 securities in its basket. Both effective maturity and effective duration of the fund are 27.25 years. This fund has a decent level of $175.6 million in AUM while sees light average daily volume of 29,000 shares. It charges 15 bps in annual fees and was up 2.1% in yesterday’s trading session (read: Safe Haven ETFs to Evade Geopolitics & Weak Economic Data).

iShares 20+ Year Treasury Bond ETF (TLT Quick QuoteTLT - Free Report)

This is the most popular and liquid ETF in the long-dated bond space with AUM of over $7.4 billion and average daily volume of 8.8 million shares. It tracks the ICE U.S. Treasury 20+ Year Bond Index, holding 33 securities in its basket. The fund has an average maturity of 26.19 years and effective duration of 17.57 years. It charges 15 bps in fees per year and added 1.5% post Fed decision.

SPDR Bloomberg Barclays Long Term Treasury ETF

This fund tracks the performance of the Bloomberg Barclays Long U.S. Treasury Index and holds 48 bonds in its basket. Average maturity and modified duration come in at 25.11 years and 17.75 years, respectively. TLO has accumulated $539.5 million in its asset base while trading in moderate volumes of 86,000 shares a day on average. It charges 10 bps in annual fees and gained 1.5% in yesterday’s session.

Vanguard Long-Term Government Bond ETF (VGLT Quick QuoteVGLT - Free Report)

With AUM of $484.2 million, this fund follows the Barclays Capital U.S. Long Government Float Adjusted Index. It holds 71 bonds in its basket with average maturity of 24.8 years and average duration of 17.5 years. The ETF trades in moderate volumes of around 95,000 shares and has 0.07% in expense ratio. The product was up 1.4% post Fed announcement (see: all the Government Bond ETFs here).

A Special Attention to iPath US Treasury Flattener ETN

This product provides inverse (or opposite) exposure to the Barclays US Treasury 2Y/10Y Yield Curve Index, which delivers returns from the steepening of the yield curve through a notional rolling investment in U.S. Treasury note futures contracts. The index takes a weighted long position in two-year Treasury futures contracts and a weighted short position in 10-year Treasury futures contracts. It generally rises when the yield curve steepens and falls when flattened. As such, investors could make smart profits from the flattening of the yield curve through the ETN thanks to its inverse relation with the index.

However, investors should note that FLAT is expensive, charging 0.75% in fees and expenses, and has a higher trading cost with average daily volume of just 11,000 shares. The note has amassed just $3.5 million in its asset base and gained 2% in yesterday’s session.
 

Bottom Line

The long-term Treasury ETFs looks interesting especially for the near term given geopolitical tensions, fears of political instability and Trump’s turmoil. Additionally, the Fed statement raised concerns over the pace of U.S. economic growth that will likely boost demand for Treasuries owing to their safe-haven status. However, the above-mentioned ETFs have an unfavorable Zacks ETF Rank of 4 (Sell) or 5 (Strong Sell), suggesting the outperformance might not last for the long as the shrinking of the Fed’s balance sheet later in the year would weigh on long-term rates.

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