The minutes of the September Fed meet showed that several officials advocated a rate hike “relatively soon.” With this, the odds of a rate hike in the final month of the year increased with a 66% probability as per the data from CME Group. The possibilities of a hike in November are low as the Fed will likely refrain from raising rates just ahead of the presidential elections (read: ETF Strategies for Q4).
That being said, low inflation remains a deterrent. But investors should note that the market has almost priced in the chances of a rate hike in December and probably this is the reason why the S&P 500 index ended in the positive on October 12, despite the Fed’s tightening signal.
Yield on 10-year U.S. Treasury note rose by 2 bps) to 1.79% on October 12 while yield on short-term three-month Treasury notes increased by 2 bps to 0.35%. Needless to say, rising rate concerns will cast a shadow on the fixed income portfolio.
Let’s find out if there are any likely winners in the fixed income space at the moment.
What Do Analysts Say?
In late September, BlackRock Inc. – the world’s biggest money manager – cautioned investors about holding long-term U.S. Treasuries and suggested to play “shorter-term corporate and municipal bonds and gold.” BlackRock specifically sees “an opportunity in municipal bonds” as it believes that “questions surrounding the U.S. government will create an upward deal flow for the municipal space.”
Meanwhile, Pacific Investment Management Co., known for running the world’s biggest actively managed bond fund, is in favor of investing in “selective opportunities in mortgages, inflation-linked bonds, and select credit markets.”
In the light of this, we highlight a few ETFs from the fixed income space that can be decent investment picks.
Muni Bond ETFs
Municipal bonds are an excellent choice for investors seeking a steady stream of tax free income. Usually the interest income from munis is exempt from federal tax and may also not be taxable per state laws, making it especially attractive for investors in the high tax bracket looking to reduce their tax liability.
Apart from investors’ desire for a tax-shelter, improving fiscal health of many municipal bond issuers and an edgy sentiment prevailing in the market on presidential elections and rising rate worries make for a rewarding combination. Munis are comparatively more stable than equity or high-yield bonds and yields better than Treasuries (read: Time to Buy Muni Bond ETFs?).
VanEck Vectors AMT-Free Long Municipal Index ETF (MLN) – Yields 3.00%
PowerShares National AMT-Free Municipal Bond Portfolio ETF(PZA - ETF report) – Yield 3.24%
Corporate Bond ETFs
Yield hungry investors intending to restrict their plays within the U.S. boundaries but not trying to expose themselves to the stock market uncertainties, may find investment grade corporate bonds compelling options.
The investment grade U.S. corporate bond market has been on a decent path lately as these normally yield more than their Treasury cousins, with only a little rise in risk (see all investment grade corporate bond ETFs here).
Plus, edgy investors need to be aware of default risks and should bet on investment-grade corporate bond ETFs. Here are the choices:
SPDR Barclays Capital Long Term Corporate Bond ETF (LWC - ETF report) – Yield 4.13%
ProShares Investment Grade—Interest Rate Hedged ETF (IGHG - ETF report) – Yield 3.55%
If a Fed hike becomes a reality soon, there must be a pickup in inflation too. Recently, New York Fed President Bill Dudley indicated that U.S. inflation expectations appear to be "well-anchored.” Though it is running short of the goal, it is far away from the deflationary threats. Also, consumer prices in the U.S. rose 1.1% year over year in August 2016, higher than 0.8% in July and market forecasts of a 1% increase. In this vein, investors can bet on the below-mentioned ETF (see all inflation protected bond ETFs here).
FlexShares iBoxx 3-Year Target Duration TIPS Index Fund (TDTT - ETF report)
The underlying index of the fund targets a modified adjusted duration of 3 years and defines the eligible universe of TIPS as having no less than one year and no more than ten years until maturity as of the Index determination date.
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