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Bond ETFs Rallying After Fed Pivot

Sumit Roy

Fixed-income ETFs are in rally mode after a dovish Fed outlook and feeble European economic data pushed bond prices sharply higher and interest rates sharply lower. Yields across the curve have tumbled, including the benchmark 10-year U.S. Treasury rate, which hit a 15-month low of 2.38% on Monday.

 

US 10-Year Treasury Yield

 

The Federal Reserve surprised markets last week when it released forecasts that suggested no rate hikes were coming this year, down from a projection of two hikes as recently as December. The Fed funds rate, which hovers between 2.25% and 2.5%, is not expected to increase due to slower economic growth and increasing overseas risks, said the central bank.

Two days later, those risks were confirmed when IHS Markit reported that its German manufacturing PMI tumbled to 44.7 in March, signaling contraction and the weakest pace of manufacturing growth since 2012.

Room For Rates To Fall?

The struggles of Europe’s largest economy only added to the list of concerns that bond traders are closely scrutinizing. China’s rapidly slowing economy and even a decelerating U.S. economy are top of mind as well.

Taken together, it certainly seems like the world is going through something of a global synchronized slowdown, much like there was a global synchronized expansion in 2017. That could be fuel for bond bulls to run prices even higher (and interest rates lower).

On the other hand, barring an even steeper deceleration in U.S. growth, Treasury yields could be limited in how much further they can fall given the current Fed funds rate. True, the 10-year yield has dropped below the top end of the Fed’s benchmark rate—but if economic growth comes in close to the Fed’s forecast of 2.1% for 2019, it’s hard to imagine a deeper inversion is in the cards.

Treasury ETF Options

Regardless of the interest rate trajectory for the rest of the year, investors have many ETF options with which to capitalize on the trend. In the case yields continue lower, high-duration funds will likely do the best.

These interest-rate-sensitive ETFs include the popular iShares 20+ Year Treasury Bond ETF (TLT) and the lesser-known PIMCO 25+ Year Zero Coupon US Treasury Index ETF (ZROZ), up 3.3% and 4.5%, respectively, so far this year.

Alternatively, if rates don’t fall further and they end up staying where they are or even rising, investors may be better off in shorter-duration ETFs. These products won’t decline nearly as much if interest rates reverse course and they still offer relatively attractive yields.

Indeed, with the yield curve as flat as it’s been this cycle, short-term bond ETFs are yielding nearly as much as some of their longer-term counterparts.

For example, the iShares Short Treasury Bond ETF (SHV), which holds Treasuries with maturities of less than one year, has a 30-day SEC yield of 2.34% compared with an equivalent yield of 2.42% for the iShares 7-10 Year Treasury Bond ETF (IEF).

By comparison, TLT, which owns Treasuries with maturities of more than 20 years, is yielding 2.79%.

For the best of both worlds, another option is the iShares U.S. Treasury Bond ETF (GOVT). It has a portfolio covering nearly the entire Treasury universe, from the 1- to 30-year maturity range. GOVT’s 30-day SEC yield currently stands at 2.39%.

Outside Of Treasuries

Of course, the bond options aren’t just limited to Treasuries. Corporate bonds and international bonds have also rallied notably in recent weeks.

The iShares iBoxx USD Investment Grade Corporate Bond ETF (LQD) has surged 6% year-to-date and sports a yield of 3.83%.

The Vanguard Total International Bond ETF (BNDX), which has heavy exposure to Japan and Europe, where rates are at ultra-low levels, rallied 2.9% so far this year. Its dollar-hedged portfolio has a 30-day SEC yield of 0.81%.

Email Sumit Roy at sroy@etf.com or follow him on Twitter sumitroy2

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