Dropping Yields Help & Hurt ETF Investors
The slump in Treasury yields is pressuring some ETFs while buoying others.
The 10-year U.S. Treasury yield dropped to a three-year low Friday—hovering around the 1.65% mark—amid a slump in sovereign yields globally. Concerns about the global economy, a rush to the safety of sovereign debt and lowering expectations for a rate hike in the U.S. are all impacting yields—and various ETFs—in different ways.
The latest pressure on U.S. yields is stemming from last week’s disappointing U.S. jobs report, which triggered a change in what the market now expects the Federal Reserve to do next. A June rate hike (Fed meets next week) is practically off the plate, and chances of another rate hike this year have decreased. According to FactSet research, the market is currently pricing about a 24% chance of a rate hike in July—down from 50% not that long ago—and about 43% by December.
Low-for-longer rates don’t bode well for banks. Financial sector ETFs are feeling the negative impact of the latest round of economic woes. Higher interest rates are good for banks, and ETFs such as the Financial Select Sector SPDR Fund (XLF | A-94) have felt the pinch of the declining confidence in the health of the U.S. economy.
Friday, XLF dropped about 1% in early trade today, putting losses in the month of June alone at 2.1%.
Ups & Downs For XLF
XLF is a good ETF proxy for the U.S. financials sector, because it’s the largest and most liquid ETF in the segment, with nearly $17 billion in assets. The fund had been trying to forge a recovery in recent months (as the chart below shows), but with growing doubts about the Fed’s ability to increase rates, it’s been hard to get financial stocks in the black.
In fact, year-to-date, financials is the worst-performing equity sector in the S&P 500, posting losses of about 1.6%. For comparison, that performance stands in stark contrast to that of the best-performing sector so far this year, the defensive-favorite utilities sector, the Utilities Select Sector SPDR Fund (XLU | A-87), which is up 17% this year. Financials are underperforming the broad S&P 500 Index by roughly 2 percentage points:
But the pressure on U.S. Treasury yields—largely linked to investors’ enormous appetite for the safety of government bonds—goes well beyond concerns about the U.S. economy and the Fed. It’s a global phenomenon that includes concerns about global growth, lack of inflation, rising geopolitical risks and even China, according to FactSet.
Negative Yields Spread
German bund and U.K. gilts yields recently dropped to record lows, while Japan’s 10-year yield is sliding further into negative territory.
This week, the World Bank added fuel to those concerns when it lowered its projected global growth outlook to 2.4% this year due to “a weaker-than-expected slowdown in emerging markets and diminished confidence in the effectiveness of central bank policies,” according to FactSet’s analysis.
The European Central Bank and the Bank of Japan are expected to remain highly accommodative, and potentially expand quantitative easing programs in the near future. The Bank of England, too, is expected to leave rates “on hold for an extended period” as it faces a possible “Brexit” in less than two weeks.
All of this should keep investors on their toes, looking for safety and for yield in longer-duration high-grade debt.
As an example, the iShares 20+ Year Treasury Bond ETF (TLT | A-83) has delivered a solid performance in this environment, as the chart below shows:
Charts courtesy of StockCharts.com
The mid-duration funds iShares 3-7 Year Treasury Bond ETF (IEI | A-73) and the iShares 7-10 Year Treasury Bond ETF (IEF | A-55) are also benefiting, with positive gains and solid investor demand—a demand that is stronger for the longer-dated funds as investors look for the highest yields.
So far this year, investors have poured $1.92 billion into TLT; $1.01 billion into IEF; and $745 million into IEI.
Contact Cinthia Murphy at [email protected].
