Israeli-Hamas War Adds to Appeal of Short-Term Bond ETFs

Message to financial advisors: It may still be too early to move off that overweighting in “cash equivalents.” 

Since the S&P 500 peaked on July 31, it has fallen 6% as of Oct. 6, even after Friday’s rally. During that same period, the yield on 10-year U.S. Treasury bonds rose from 3.97% to 4.72%, a 75-basis point move. What happened to six-month Treasury bill rates over that time frame? Nothing. They moved from 5.53% to 5.56%.  

That’s good news for financial advisors and their clients, because it allows them more time to let the markets and the world sort things out and move ahead, despite an increasing list of risks to stock and bond investors. Owners of ETFs that hold T-bills and higher quality short-term bonds are still solid investments. Yes, boring is still beautiful. 

When T-bill rates did their version of a “10X,” moving from 0.5% to 5% from February 2022 through February 2023, advisors may have thought it that dramatic change as a good news-bad news situation. 5% T-bills were a nice low-risk asset, but, for how long? The Federal Reserve could reverse course and drop those rates toward 2-3% once they feel confident that the inflation dragon has been slayed.  

Treasury ETFs Poised for 5% Returns 

But a few months later, that looks less likely to happen soon, barring an outsized market reaction to recent or near-term future events. Inflation is not done, and neither is the Fed. Because a “pause” in the fed-funds rate, which is more closely tied to T-bill rates than to longer-term bonds, would mean that ETFs that deliver Treasury-level security at a 5% rate could continue doing so for longer than many might have expected.

And with the bond market and stock market in bearish trends for months, there may be little urgency to re-establish large allocations to traditional stock-bond allocations for risk-averse clients. 

Even last Friday’s jobs report, which for a day took the stock market out of its weeks-long slump, may end up requiring more scrutiny. The report indicated that leisure industries and government hires were a significant part of the job increases, and many new jobs were part-time, second jobs. That could mean that more than a year of higher inflation has driven many people to increase their income by adding a second job. That’s hardly a picture of a roaring economy. 

The stock and bond markets have been in a funk since the middle of the summer, and any turnaround risks being short-lived until much firmer footing is established for market bulls. That brings advisors’ attention back to the fact that short-term rates are still as attractive as they were eight months ago, and rates of at least 5% can be had out to two years in maturity. 

Two Short-Term Treasury ETFs 

Exchange-traded funds offer a vast number of vehicles to position portfolios to capture those favorable short-term returns.  

The SPDR Portfolio Short Term Treasury ETF (SPTS) patrols the 12–36-month part of the U.S. Treasury yield curve. The $5.81 billion fund yields 5.04% and is in recovery mode from its “crash” of 5.7% from September 2021 through November 2022. It would take a move in two-year Treasuries greater than the one we just had to repeat that, so the storm may have passed for this segment of the bond curve. 

T-bill ETFs like the $455 million US Treasury 6 Month Bill ETF (XBIL) go even a step further than SPTS. This ETF made its debut in March of this year, just in time to take advantage of the highest T-bill returns many investors have ever seen. It simply holds the last issued six-month Treasury bill.  

That used to be a nonstarter for advisors because yields in that part of the curve were well below their advisory fee. But at a time when a changing consumer economy, persistent inflation and increasing geopolitical conflict add more hurdles to making effective investment choices, the relatively free lunch of short-term bonds still has a place at the table. Boring is still beautiful.