JPM Survey: Rates Will Fall If US Defaults

As U.S. political leaders continue to drive toward a deal that will allow the debt ceiling to be raised to prevent a looming default, no one knows exactly how it will turn out and how sustainable the immediate reactions will be. 

On Monday, Treasury Secretary Janet Yellen reiterated her assessment that the U.S. will run out of out cash in early June, as soon as eight days from now. 

As part of an extensive report published last Friday, J.P. Morgan said that “in the unlikely event of a technical default, we think Treasury yields would decline and the curve would steepen.”  

While that view may provide momentary comfort, a default of any kind might be a very emotional event for markets. That is why it helps to have a "trapdoor" to run through if rates spike instead of dipping.  

The following exchange-traded funds offer a different route to capitalize on a continued increase in interest rates, whether that occurs as a knee-jerk reaction to the debt ceiling drama, or takes hold during the summer, when the markets finally shift their attention elsewhere. 

ProShares Short 20+ Year Treasury ETF (TBF) 

Many investors are familiar with ETFs that can be used to profit from a falling stock market. But similar vehicles exist to profit from bond price declines. TBF aims to produce a return that is the opposite of the ICE U.S. Treasury 20+ Year Bond Index by using swaps and futures contracts, backed by T-bills.  

So, if long-term U.S. Treasury bond rates fly higher, as they did throughout 2022, this ETF is in prime position. TBF soared by 42% last year, but is down 1% so far in 2023, as long-term rates have remained range-bound.  

While this ETF has just $185 million in assets, its $10 million average daily trading volume implies that investors tend to use TBF as a trading vehicle, similar to other so-called inverse ETFs. 

ProShares Short 7-10 Year Treasury ETF (TBX) 

TBF has a cousin of sorts. TBX takes the same approach as that fund, but focuses on a shorter area of the yield curve: seven- to 10-year U.S. Treasuries. This fund has only $30 million in assets, after rising 18% in 2022. In this part of the ETF market, it appears that asset flows do not always follow strong returns. 

iShares Treasury Floating Rate Bond ETF (TFLO) 

Investors have discovered this $6 billion ETF, which invests in U.S. Treasury notes that have “floating” interest rates. That is, as market rates fluctuate, so does the rate of the bonds held here.  

Importantly, the entire TFLO ETF portfolio is invested in bonds maturing in under three years. That has helped it capitalize on the current “inverted yield curve” situation, where shorter-term bond yields are higher than long-term yields.  

The ETF’s yield to maturity current stands right around 5%. It has also not had a decline from any high to low point of more than 5% in its nine-year history. 

ProShares Equities for Rising Rates ETF (EQRR) 

Equities can play this game too. And this ETF does, by focusing on five of the 11 S&P 500 subsectors, the ones that tend to perform best during periods of rising interest rates: energy, basic materials, financials, industrials and telecommunications. EQRR also fits squarely into the “overlooked” category, at only $43 million in assets following a 36% gain in 2021 and a 2% gain during 2022.  

The debt ceiling is an event. But exploiting or defending against rising rates will likely be an ongoing priority for ETF investors in the new world of nonzero interest rates.