The start of 2018 has shaken the fixed income world thanks to the steep rise in yields. As of Jan 9, 2018, the yield on the benchmark 10-year Treasury note was 2.55%, the highest since March 15, while the year started with a benchmark bond yield of 2.46%.
Global Rising Rate Worries
The news that the Bank of Japan has reduced its monthly bond purchases reinforced the fact that several developed global central banks are eyeing policy tightening this year. The central bank bought JPY190 billion (US$1.7 billion) of 10-25-year paper compared to JPY200 billion in its last operation. The bank purchased JPY80 billion in longer, 25-year-plus bonds, lower than JPY90 billion bought earlier.
Investors should note that the Fed has enacted five rate hikes since December 2015. Though benchmark treasury bond yields remained at subdued levels throughout 2017, many Fed officials also gave hawkish comments recently.
All these moves and comments have started boosting bond yields since the start of 2018. The U.S. 3-year note yield, which is linked to traders' views on the Fed policy, was 2.074%, marking its highest point since the instrument was reissued in 2007.
The optimism around the economy and the stock market is so high that the San Francisco Fed President John Williams recently talked about the strength in the world's largest economy which is likely to operate “at or near its full capacity over the next few years.” The policymaker sees three rate hikes as sensible in 2018 (read: 5 High Dividend ETFs Off to a Great Start in 2018).
On the other hand, Federal Reserve Bank of Cleveland President Loretta Mester expects around four interest-rate hikes this year, thanks to strength in the economy and labor market. With both Fed bodies having a vote on Fed policy this year under rotation, such comments are quite capable of impacting the bond market.
The story is same with the ECB as well. The ECB used to buy bonds at a pace of 60 billion euros ($70 billion) per month. The central bank announced in October that the bank would extend the program from January at a pace of 30 billion euros until at least September 2018. An analyst termed the move as a "gentle exit" from its quantitative easing program. This indicates the central bank’s intension to leave the ultra-easy monetary policy era in 2018.
If these were not enough, Chinese officials are reportedly mulling over halting or slowing the buying of U.S. Treasuries as these are becoming less attractive that the other assets. Trade tensions between two economies are deemed to cause such thinking. Since China is the biggest purchaser of U.S. sovereign debt, the report may hit the U.S. bond market badly.
Against this backdrop, bond yields are rising, which means that the bull market for bond ETFs is coming to an end (read: Bull Market for Bond ETFs Coming to an End?)
ETFs to Play
If bond yields remained on such an uptrend, investors can play the inverse bond ETFs like ProShares Short 20+ Year Treasury ETF (TBF - Free Report) , ProShares UltraShort 20+ Year Treasury ETF (TBT - Free Report) and Direxion Daily 20+ Year Treasury Bear 3X ETF (TMV - Free Report) (read: 4 Inverse Bond ETFs to Watch as Rates Rise).
Private Equity ETFs
As bond yields have started to rise, investors now need to focus on stable bets that offer way higher than the benchmark yield. For this, the private equity ETF pack is an option. Investors should note that this asset class is high dividend in nature. PowerShares Global Listed Private Equity ETF (PSP - Free Report) yields about 9.85% annually.
Niche Bond ETFs
Floating rate notes are investment grade bonds that do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of the issuers. iShares Floating Rate Bond (FLOT - Free Report) is a good bet in this context. Another option in this space is to tap bank loan ETFs like Highland/iBoxx Senior Loan ETF (SNLN - Free Report) .
By choosing the investment grade bonds portfolioProshares Investment Grade-Interest Rate Hedged (IGHG, investors can get rid of rising rate worries through an interest rate hedge approach using U.S. Treasury futures. The fund yields about 3.35% annually.
High Dividend ETFs
Investors can seek refuge in even higher yield securities. So, PowerShares S&P 500 High Dividend Portfolio (SPHD - Free Report) yielding about 3.53% annually, can be a nice bet in a rising rate environment. Fidelity Dividend ETF for Rising Rates (FDRR) can also be a good pick right now.
Bank stocks are good bets now in a rising rate environment. Apart from rising rates, Trump’s tax cut plans are likely to bring good news for bank stocks. SPDR S&P Bank ETF (KBE - Free Report) and PowerShares KBW Regional Banking ETF (KBWR - Free Report) should prove to be lucrative bets (read: ETFs to Bet on the Final Tax Bill: What Hot, What's Not).
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