If you have read the latest news, you know that a lot of people are focusing on the yield curve and its current shape. This is because the term structure of the curve provides important information on market expectations for future economic growth and levels of inflation.
Moreover, the current curve shape resembles the one seen in the years 2006 and 2000, which would precede the “great financial crisis.” So, let’s take a closer at the curve’s recent action, how it is shaping bond ETF performance, as well as look back at other periods with a similar behavior.
Lower Yields, High Prices
As seen in the chart below, the yield curve has shifted downward in 2019, driving the outperformance of broad market bond ETFs (lower yields = higher bond ETF prices).
For a larger view, please click on the image above.
The Bloomberg Barclays Aggregate Market Index, a benchmark for the largest U.S. core bond ETFs, boasts a robust year-to-date total return of 8.78%. Because broad market bond ETFs hold a portfolio of several maturities, they have been the most convenient way for traders to gain access to the market.
Throughout 2019, they have gathered around $43 billion in new assets compared with only $7.6 billion in inflows last year.
Shrinking Spread
At the start of the year, the spread between three-month and 30-year maturities stood at 55 basis points. As of Aug. 15, the spread stood at a mere 7 basis points. This has caused long-term ETFs to rally. The iShares 20+ Year Treasury Bond ETF (TLT) and the Vanguard Extended Duration Treasury ETF (EDV) boast impressive total returns of 23.20% and 30.60%, respectively, as of Aug. 14, 2019.
Additionally, the three-month yield inversion is notable between the three- and five-year maturities. The spread between the three-month rate and the three-year is negative 0.49%, meaning intermediate bond ETF investors are willing to pay higher prices and receive lower monthly distributions than invest in ultra-short-term ETFs.
This market action hints that the Fed will cut rates by around 0.75% in the upcoming months. As of Aug. 14, 2019, the Schwab Intermediate-Term U.S. Treasury ETF (SCHR) and the SPDR Bloomberg Barclays Intermediate Term Treasury ETF (ITE) have year-to-date total returns of 7.34% and 7.37%, respectively.
