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Lael Brainard, the Federal Reserve governor, who had for months argued in favor of keeping the rates down for longer, has finally supported the case for a rate hike soon. The U.S. economy seems to be improving and the case for rate normalization seems to be getting strong. Moreover, hawkish comments from the Fed President of New York and San Francisco, William Dudley and John Williams have further fueled the expectations.
The tables seem to have turned, as witnessed by the Fed funds futures data, with the odds of a rate hike going sharply up to more than 66% on March 1 from 32% on Tuesday, February 28th.
Rising Yields
Yields on 10-year and 20-year US Treasuries have reached 2.45% and 2.80%, respectively. Treasuries are generally considered safe havens in periods of rising interest rates and growing economy. Bond yields trend higher and hence prices go down, since they are inversely correlated. Moreover, long-term investors are hurt the most owing to the higher duration of their investments, and hence higher sensitivity (read: Why Are Active Fixed Income ETFs Flushing the Market?).
After a careful consideration of these factors, it’s clear that exposure to longer dated bonds are risky in this rising rate environment. Therefore, given the current scenario, avoiing longer-term bond ETFs is the key. We believe the spotlight will be on the following ETFs:
iShares 7-10 Year Treasury Bond ETF (IEF - Free Report) :
This ETF offers intermediate term exposure to fixed income investors looking for moderate levels of risk but at the same time getting higher income than their short term counterparts when the economic factors favor the investment.
The fund manages an AUM of $7.55 billion and tracks the Barclays Capital U.S. 7-10 Year Treasury Bond Index. It has a low expense ratio of 15 bps and a weighted average duration of 7.5 years. The fund has a year-to-date return of 0.10% and a one-year return of -3.50%. As such, IEF has a Zacks Rank #4 (Sell) with a High risk outlook.
iShares 10-20 Year Treasury Bond ETF (TLH - Free Report) :
This ETF offers longer term exposure to fixed income investors looking for comparatively higher levels of risk and to lengthen the effective duration of their bond portfolio. It can be useful for enhancing fixed current income by taking on additional duration risk.
The fund manages an AUM of $493 million and tracks the Barclays Capital U.S. 10-20 Year Treasury Bond Index. It has a low expense ratio of 15 bps and a weighted average duration of 9.83 years. The fund has a year-to-date return of 0.43% and a one-year return of -4.02%. As such, IEF has a Zacks Rank #4 (Sell) with a High risk outlook.
iShares 20+ Year Treasury Bond ETF (TLT - Free Report) :
TLT is an appropriate core holding for investors seeking an exposure to the longest end of the Treasury Yield Curve. Long-term treasury bonds are expected to provide stable return as these are less risky than other bonds including junk bonds (read: Junk Bond ETFs in Troubled Space?). It can be useful when it comes to enhancing current income by taking on extreme levels of duration risk.
The fund manages an AUM of $493 million and tracks the Barclays Capital U.S. 20+ Year Treasury Bond Index. It has a low expense ratio of 15 bps and a weighted average duration of 17.6 years. The fund has a year-to-date return of 0.50% and a one-year return of -5.44%. IEF has a Zacks Rank #5 (Strong Sell) with a High risk outlook.
Bottom Line:
The current economic scenario, with the odds of another rate hike in the March 14-15 FOMC meet up and markets reaching all-time highs due to investor optimism, expected tax reforms and expected cut down on banking regulations, does not favor fixed income investments. As a result, it would be best to adopt a short strategy for now.
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Another Rate Hike in the Cards: ETFs in Focus
Lael Brainard, the Federal Reserve governor, who had for months argued in favor of keeping the rates down for longer, has finally supported the case for a rate hike soon. The U.S. economy seems to be improving and the case for rate normalization seems to be getting strong. Moreover, hawkish comments from the Fed President of New York and San Francisco, William Dudley and John Williams have further fueled the expectations.
The tables seem to have turned, as witnessed by the Fed funds futures data, with the odds of a rate hike going sharply up to more than 66% on March 1 from 32% on Tuesday, February 28th.
Rising Yields
Yields on 10-year and 20-year US Treasuries have reached 2.45% and 2.80%, respectively. Treasuries are generally considered safe havens in periods of rising interest rates and growing economy. Bond yields trend higher and hence prices go down, since they are inversely correlated. Moreover, long-term investors are hurt the most owing to the higher duration of their investments, and hence higher sensitivity (read: Why Are Active Fixed Income ETFs Flushing the Market?).
The markets seem to be soaring continuously on the Trump rally with the DOW reaching an all-time high of 21,000 (read: Trump Sets Bullish Tone: Grab These Top-Ranked ETFs). This shows investor confidence in the economy and hence less likelihood for favoring safe haven investments (read: Dow Jones Hits 12th Session of Record High: ETFs in Focus).
After a careful consideration of these factors, it’s clear that exposure to longer dated bonds are risky in this rising rate environment. Therefore, given the current scenario, avoiing longer-term bond ETFs is the key. We believe the spotlight will be on the following ETFs:
iShares 7-10 Year Treasury Bond ETF (IEF - Free Report) :
This ETF offers intermediate term exposure to fixed income investors looking for moderate levels of risk but at the same time getting higher income than their short term counterparts when the economic factors favor the investment.
The fund manages an AUM of $7.55 billion and tracks the Barclays Capital U.S. 7-10 Year Treasury Bond Index. It has a low expense ratio of 15 bps and a weighted average duration of 7.5 years. The fund has a year-to-date return of 0.10% and a one-year return of -3.50%. As such, IEF has a Zacks Rank #4 (Sell) with a High risk outlook.
iShares 10-20 Year Treasury Bond ETF (TLH - Free Report) :
This ETF offers longer term exposure to fixed income investors looking for comparatively higher levels of risk and to lengthen the effective duration of their bond portfolio. It can be useful for enhancing fixed current income by taking on additional duration risk.
The fund manages an AUM of $493 million and tracks the Barclays Capital U.S. 10-20 Year Treasury Bond Index. It has a low expense ratio of 15 bps and a weighted average duration of 9.83 years. The fund has a year-to-date return of 0.43% and a one-year return of -4.02%. As such, IEF has a Zacks Rank #4 (Sell) with a High risk outlook.
iShares 20+ Year Treasury Bond ETF (TLT - Free Report) :
TLT is an appropriate core holding for investors seeking an exposure to the longest end of the Treasury Yield Curve. Long-term treasury bonds are expected to provide stable return as these are less risky than other bonds including junk bonds (read: Junk Bond ETFs in Troubled Space?). It can be useful when it comes to enhancing current income by taking on extreme levels of duration risk.
The fund manages an AUM of $493 million and tracks the Barclays Capital U.S. 20+ Year Treasury Bond Index. It has a low expense ratio of 15 bps and a weighted average duration of 17.6 years. The fund has a year-to-date return of 0.50% and a one-year return of -5.44%. IEF has a Zacks Rank #5 (Strong Sell) with a High risk outlook.
Bottom Line:
The current economic scenario, with the odds of another rate hike in the March 14-15 FOMC meet up and markets reaching all-time highs due to investor optimism, expected tax reforms and expected cut down on banking regulations, does not favor fixed income investments. As a result, it would be best to adopt a short strategy for now.
Want key ETF info delivered straight to your inbox?
Zacks’ free Fund Newsletter will brief you on top news and analysis, as well as top-performing ETFs, each week. Get it free >>