McCall’s Call: Bond ETFs For Higher Rates

April 06, 2011

An investor’s toolbox to cope with rising rates has never been fuller.

 

There are two ways to look at the current state of interest rates in the U.S. On the one hand, they’re certainly higher than where they were late last year, and yet they’re still very low in historical perspective. For now, both those views are true, but it’s probably also a decent bet that rates will be heading even higher before long.

Matthew D. McCallThe yield on the 10-year bond ended trading today at 3.55 percent, much higher than the 2.34 percent low from last October. That 51 percent increase in the yield is significant, but still a far cry from the 15.84 percent yield that the benchmark Treasury note reached in 1981.

Yields that high may never come to pass again. But, whatever happens, it’s clear the ETF industry is shifting into high gear in terms of bringing new products to market that could give investors the tools they’ll need to survive the transition to higher rates when the Federal Reserve starts to tighten credit again.

For example, a slew of inverse bond ETFs are becoming available that weren’t around the last time financial markets headed into a cycle of rising rates, and it’s important for investors to at least be aware of the choices that are out there.

What’s Next?

The consensus estimate among analysts is for interest rates to keep increasing this year and into 2012.

A combination of a strong equity markets and the near-certainty of inflation will force the Fed to begin raising interest rates in the coming months.

Fed Chairman Ben Bernanke continues to brush off the inflation concerns that are sweeping the market, but his hand will be forced to move rates from their historic lows sooner rather than later.

For the yield on the 10-year note to get back to prerecession levels, it has to increase to 5.31 percent, another 50 percent from the current level.

In the event rates do get that high, which I think is almost a certainty over the next 12 months, how will this affect the market and ETFs?

 

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