Bond ETFs Retreat on Hotter PPI, Rate Cut Still Expected

The Producer Price Index (PPI) ticked higher in November, pushing the bond market proxy iShares 20+ Year Treasury Bond ETF (TLT) and other long bond ETFs lower as fixed-income investors expect interest rates to remain higher for longer. 

The PPI, which focuses on the prices paid to producers versus consumers, rose this past month, up 0.4% in November compared to 0.3% consensus and 0.3% the prior month.

Higher interest rates negatively impact bond prices, particularly for long-duration bond ETFs like TLT, which fell 1.2% Thursday, as their fixed payouts become less attractive relative to new bonds offering higher yields.

A slightly higher PPI suggests rising costs for producers, which can lead to higher consumer inflation down the line. This often prompts expectations of tighter monetary policy or higher interest rates, which reduce the attractiveness of bonds and cause bond ETF prices to decline. 

Meanwhile, a rate cut is still expected next week when the Federal Open Market Committee (FOMC) meets as Fed Funds Futures give a 94% probability that the Fed will cut by 25 basis points. 

A silver lining to the PPI is that core PPI, which excludes volatile food and energy prices, rose 0.2% month-on-month, which is in line with consensus and down from 0.3% in the prior month.

PPI and Its Impact on Bond ETFs

The Producer Price Index (PPI) measures the average change over time in the selling prices received by domestic producers for their output, reflecting price trends at the wholesale level. Unlike the Consumer Price Index (CPI), which tracks the cost of goods and services to consumers, the PPI focuses on the prices paid to producers, making it a leading indicator of inflationary trends within the production pipeline.

Impact on Bond ETFs

A rising PPI signals higher inflation, potentially prompting the Federal Reserve to maintain or increase interest rates to manage inflation. Higher interest rates negatively impact bond prices, particularly for long-duration bond ETFs like TLT, as their fixed payouts become less attractive relative to new bonds offering higher yields.

Investors often use PPI data alongside other economic indicators to gauge inflation trends and adjust their fixed-income allocations accordingly.