Short Treasuries in Spotlight as Rates Rise

Investors are piling into iShares' SHV as stagflation concerns increase

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Reviewed by: Andrew Hecht
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Edited by: Andrew Hecht

While the Federal Reserve determines the short-term fed funds rate, the market established interest rates further out along the yield curve.  

There are significant differences in rates, from the very-short-term fed funds rate to the 30-year Treasury bonds and all the different maturities. After years of historically low interest rates, addressing inflation has caused an enormous bump up. The fed funds rate moved from a midpoint of 0.125% in March 2022 to 4.625% in March 2023.  

The iShares Short Treasury Bond ETF (SHV) holds U.S. bonds under one-year maturity. It’s a highly liquid product that’s attracting lots of action and inflows in the current environment.  

SHV Tracks the ICE U.S. Short Bond Index 

SHV holds risk positions in U.S. bonds, tracking the ICE Short U.S. Treasury Securities Index. The ICE Index is a value-weighted fixed-rate-only instrument excluding zero-coupon STRIPS. Since it holds one-month to one-year debt securities, ICE rebalances the index each month-end. The index takes a snapshot of the bonds comprising the index at 3:00 P.M. each business day.  

Bond prices and yields have an inverse relationship. Investors can use SHV to hedge against adverse price action in the bond market that impacts the yield curve, as short and long maturities don’t necessarily move together. The monthly resets make for an odd formation on charts.

 

Source: ETF.com 

 

The above chart shows the month-to-month patterned price action in SHV. Since supply and demand for debt securities in the bond market establishes medium- and long-term interest rates, SHV is a hedging tool that can reflect the changes in bond prices and the market’s sentiment for the future path of interest rates.  

The most powerful impact of rising rates occurs in deferred maturities because of mortgages and other long-term debt obligations. Bond investors can experience significant losses when bonds decline. SHV is an ultra-short bond ETF that can hedge these portfolios to minimize the rising interest rate risk.  

Fed Tightening Has Slowed 

In 2022, the U.S. central bank aggressively battled the highest inflationary pressures in decades.

 

Source: Forbes.com 

 

The above chart highlights four consecutive 75 basis point fed funds rate increases from June through November 2022. Last year, the short-term rate rose 4.50% starting in March 2022. In 2023, the Fed has only raised rates by 25 basis points and is unlikely to repeat the trajectory of the 2022 rate hikes.  

SHV Has Seen Significant Inflows 

SHV is a highly liquid product. At $110.01 per share, it had around $20 billion in assets under management. SHV trades an average of over 5 million shares daily and charges a 0.15% management fee. Since bonds have yields, SHV’s annual dividend of $1.89 per share translates to a 1.72% yield.  

 

Source: ETF.com 

 

As the above chart shows, as of March 3, $2.46 billion flowed into SHV over the past five days, and $4.11 billion moved in over the past 30 days. The positive flow indicates that market participants are using SHV to hedge interest rate risks.  

Stagflation Concerns 

While the Fed and other worldwide central banks have tightened monetary policy to combat inflation, such policies tend to impact an economy’s demand side. Supply-side inflation caused by the ongoing war in Ukraine, the bifurcation of the world’s nuclear powers and postpandemic supply chain issues can be immune to rising interest rates.  

Markets across all asset classes reflect the economic and geopolitical landscapes, and bonds are no exception. Tightening credit slows the economy, but persistent inflation in a rising rate environment can cause economic contraction with high inflation.  

Stagflation challenges the Fed and other central banks as the condition requires opposing monetary policy tools. While increasing interest rates address inflation, cutting rates treats a recession. Therefore, stagflation presents unique and complex conditions and tools.  

Increasing Bond Market Participation 

Falling bonds and stocks have caused many market participants to adjust their portfolios to take advantage of increased interest rates. For many years, stocks have been the asset of choice for investors saving for the future. However, with rates moving dramatically higher over the past year, more capital flows into the bond market as investors look to take advantage of higher fixed income yields.  

A volatile stock market trending lower is a primary reason for increased participation in the bond market. From 2020 through 2022, artificially low interest rates drove capital to stocks. Until late 2021, a 30-year fixed-rate conventional mortgage was below 3%, while today it tops 7%.  

On a $400,000 loan, the significant monthly increase amounts to over $1,300. While higher rates are weighing on the housing market, they have made bonds far more attractive investment vehicles. Therefore, products like SHV will likely see rising participation if interest rates continue to trend higher over the coming weeks and months.  

Andrew Hecht is a Nevada-based writer and analyst covering stocks, bonds, foreign exchange, cryptocurrency and raw material markets. He has over four decades of experience in markets across all asset classes, concentrating on commodity markets. Hecht was a senior trader at Salomon Brothers in the 1980s and 1990s, running sales and trading businesses. In 2013, McGraw Hill published his book, “How to Make Money in Commodities."