Speculation over the Federal Reserve’s exit from its massive QE program is having a huge impact on the bond markets. Rates on the 10 Year Treasury bond have soared in the past six weeks, rising from a low around the 1.6% mark, to roughly 2.45% today.
This is forcing many investors to reevaluate their holdings, especially in the bond world. Funds targeting this space have seen modest losses, and with the prospect of actual tapering as early as this year, the red in these products could increase (see 4 ETFs on the move After Bernanke’s Press Conference).
Fortunately, there are a number of ways that investors can avoid these interest rate risks, or even benefit from them. While senior loan or floating rate ETFs look to avoid the worst of the interest rate spike, investors can arguably directly benefit from rising rates by using inverse bond ETFs.
Better picks in a rising rate environment?
Inverse bond ETFs are securities that pay out a rate of return that is equal, but opposite, to a ‘regular’ bond benchmark. So for example, in a -1x bond ETF, if bond prices slump by 1% this fund should rise by 1%.
Since bond prices generally fall when rates are rising, inverse bond ETFs could make for great picks in a rising interest rate environment. This could be especially true if investors focus in on the long-end of the curve (read Long Term Treasury Bond ETF Investing 101).
In this part of the bond curve, movement in interest rates and expectations of future payouts can have a huge impact on prices. After all, if you are holding a 30 year bond and current rates surge, you are locked in for a much longer time period than an investor who is holding a bond that matures five years from now, a worrisome situation when new bond investments are sporting higher payouts.
How to Play
Investors have a number of options in the inverse bond market, but we have decided to focus on the long-end of the curve with leverage. This is because ETFs in this segment not only benefit the most from rising rates, but can be the biggest short-term winners making them excellent choices for traders in this type of environment.
Some of the top choices in this segment include the following ETFs, all of which have surged in the past one month time frames when compared to their unleveraged counterpart:
1 month performance
-2x, daily resetting
-3x, daily resetting
-3x, monthly resetting
As you can see, shifting expectations about the Federal Reserve’s easing program has had a dramatic impact on the long term bond market. So if you think this can continue in the near term, these inverse funds might be great picks, although it is worth remembering that they are likely to experience extreme volatility, especially over longer time periods (also see Understanding Leverage ETFs).
For more on inverse bond ETF investing, and how these have stacked up against their counterparts on the long side, make sure to watch our short video on the subject below:
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