A Magic Moment for Short-Term Bond ETFs

More rate hikes may be coming, and investors may want funds less sensitive to such moves.

sumit
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Senior ETF Analyst
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Reviewed by: Sumit Roy
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Edited by: Sumit Roy

After decelerating in last year’s final three months, inflation ticked up in January. Tuesday’s consumer price report jarred stock investors, who responded in the aftermath by selling shares. The SPDR S&P 500 ETF Trust (SPY) fell by as much as 1% on Tuesday morning. 

But by the end of the day, the ETF had recovered, finishing little-changed. Sure, the CPI data for January wasn’t ideal, but investors signaled they’re confident that the disinflationary trend that began late last year is still in place.  

Combined with the super-strong jobs report from earlier this month—which showed the unemployment rate hitting a five-decade low—that confidence is why SPY is trading 15% above its bear market lows and why the Invesco QQQ Trust (QQQ) is up by 18% from its trough. 

But even as the stock market brushes off the inflation and jobs reports (or even interprets them in a positive light), the same can’t be said of the bond market.  

Immediately after the release of the CPI report on Tuesday, the two-year Treasury bond sold off, pushing its yield to a three-month high (bond prices and yields move inversely). At 4.61%, the two-year yield is just a hair below the 15-year high of 4.72% set in November. 

 

 

The yield moved up because the recent data we’ve gotten on jobs and inflation suggest the Fed will keep hiking rates. 

Contrary to the optimistic expectations of several weeks ago, the rate hiking cycle probably isn’t over. Probabilities based on fed fund futures imply that the central bank will hike rates another three times in March, May and June. 

Those expectations could change, of course. Every economic data point seems to shift the market’s belief in what the Fed is going to do and how long there is to go before the central bank finally calls it quits on rate hikes. 

But the fact of the matter is that, time and time again, the market has underestimated how high the central bank is willing to take interest rates. Yes, the central bank will stop at some point, and probably in the not-too-distant future. 

Maybe it’ll be at 5%, or 5.5% or even 6%—no one, not even the Fed, knows for sure. 

For bond investors, that’s a bit of a quandary. Rising interest rates push prices for bonds lower, so an uncertain peak for rates translates into an uncertain trough for prices.  

Yet not all bonds are impacted by rising rates to the same extent. Low-duration bonds—those that pay investors back faster—are less sensitive to interest rate fluctuations.  

In fact, this is an ideal environment for short-duration bond ETFs. They offer investors high and rising interest rates while insulating them from downward lurches in prices caused by larger-than-expected Fed rate hikes. 

The iShares 0-3 Month Treasury Bond ETF (SGOV), which currently yields around 4.3%, is a great example of this.  

Check out ETF.com’s ultra-short term ETF channel for most fund options in this category. 

 

Email Sumit Roy at[email protected]or follow him on Twitter@sumitroy2                

Sumit Roy is the senior ETF analyst for etf.com, where he has worked for 13 years. He creates a variety of content for the platform, including news articles, analysis pieces, videos and podcasts.

Before joining etf.com, Sumit was the managing editor and commodities analyst for Hard Assets Investor. In those roles, he was responsible for most of the operations of HAI, a website dedicated to education about commodities investing.

Though he still closely follows the commodities beat, Sumit covers a much broader assortment of topics for etf.com, with a particular focus on stock and bond exchange-traded funds.

He is the host of etf.com’s Talk ETFs, a popular video series that features weekly interviews with thought leaders in the ETF industry. Sumit is also co-host of Exchange Traded Fridays, etf.com’s weekly podcast series.

He lives in the San Francisco Bay Area, where he enjoys climbing the city’s steep hills, playing chess and snowboarding in Lake Tahoe.