TLT Tanks, SGOV Rises in Mixed Year for Fixed Income ETFs
Interest-rate sensitivity was key in 2024 for fixed income ETFs.
For most fixed income ETFs, 2024 has been a bit of a disappointment. With just three trading days left in the year, the iShares Core US Aggregate Bond ETF (AGG) has returned 0.9%, far less than the 5.3% year-to-date gain it had in September, and well below its 5.7% return for 2023.
Fixed-income exchange-traded funds in general have sold off over the past few months as it’s become clear that the Federal Reserve’s rate-cutting cycle won’t be as aggressive as many had thought.
In fact, market-based indicators suggest that the U.S. central bank might not cut its benchmark federal funds rate at all in 2025, while Fed officials penciled in only two rate cuts for next year in their latest Summary of Economic Projections released earlier this month.
Better-than-expected economic growth and labor market conditions combined with lingering worries about inflation have caused the Fed to reign in its rate-cutting agenda. Uncertainty about the incoming Trump administration and its impact on growth and inflation have also pushed the Fed to the sidelines for now.
Pockets of Strength
Despite the middling returns for many fixed income ETFs, if you look hard enough, you can find pockets of stellar performance.
Ultra-short-term bond ETFs, for example, have delivered handsome returns this year: the iShares 0-3 Month Treasury Bond ETF (SGOV) is up by 5.2%.
Unlike more interest-rate-sensitive bond ETFs, SGOV’s price held steady despite the jump in yields this year.
On the other hand, highly rate-sensitive funds, like the iShares 20+ Year Treasury Bond ETF (TLT) headed sharply lower. That fund delivered a negative return of 7.5% in the year-to-date period through Dec. 24 as price declines more than offset the ETF’s yield.
Funds with mid-levels of interest rate sensitivity, like the aforementioned AGG, the iShares 7-10 Year Treasury Bond ETF (IEF) and the iShares iBoxx $ Inv Grade Corporate Bond ETF (LQD) are ending the year around the flatline, with gains or losses of about 1%.
Where Rates Stand
Rate sensitivity has been a big factor in this year’s fixed income ETF performance.
Despite 100 basis points of Fed rate cuts this year, yields on intermediate and long-term Treasury bonds are ending the year close to their highs.
The 10-year Treasury yield was last trading at 4.61%, up from 3.88% at the start of the year and close to its 2024 high of 4.7% from April.
The 30-year Treasury yield was last trading at 4.78%, up from 4.03% at the start of the year and just a smidge below its 2024 high of 4.81% from April.
On the other hand, the 2-year Treasury yield, which is tied more closely with the Fed’s benchmark rate, was last trading at 4.35%, up just a tad from 4.25% at the start of the year and well below its 2024 high of 5.04% from April.
In addition to their yields, bond ETFs’ total returns are impacted by movements in their price. As yields move up, prices go down (and vice versa). The magnitude of the price impact is greater for long-term bonds than it is for short-term bonds.
Investors who stayed on the shorter end of the yield curve fared better this year than those who overweighted long-term bonds.
If yields keep rising, the same will likely hold true in 2025, whereas if rates decline, long-term bond exchange-traded funds like TLT could start to perform better.
Credit Spreads
While interest-rate sensitivity, or duration, was a big factor in driving fixed-income ETF returns this year, credit spreads weren’t—at least for investment-grade bonds.
Credit spreads for U.S. investment-grade corporate bonds reached their lowest levels since the 1990s this year, boosting the performance of ETFs that hold those bonds, like LQD.
But spreads were already at low levels entering 2024, so the extra return from the narrowing spreads wasn’t all that much.
Spreads on high-yield bonds narrowed more, and that tailwind combined with the higher yields on those bonds led to a solid 8% return for the iShares iBoxx $ High Yield Corporate Bond ETF (HYG). For context, this particular ETF returned 11.5% last year.
The flipside of low credit spreads is that the bias of risks now tilts to the downside; if the economy weakens and spreads widen, returns for corporate bond ETFs will be hurt relative to Treasury bond ETFs. On the other hand, if the economy remains resilient, spreads might not narrow much given that they are already at such low levels.