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Investors Flock to Short Duration Bond ETFs as Producer Prices Rise

This article was originally published on ETFTrends.com.

For the month of September, the Labor Department revealed that the core producer price index (PPI) increased by 0.2%, which was in line with expectations from a Reuters poll of economists. Furthermore, the PPI rose 2.5% in the 12 months through September, which also matched expectations.

“This latest inflation data corroborates our view that the Fed is likely to move ahead with another rate hike in December, bringing this year’s total to four,” economists at Oxford Economics wrote.

Core PPI is key indicator for underlying producer price pressures, excluding food and energy costs. The Federal Reserve uses the PPI data as a measure of inflation where producers who are paying more for goods may translate to higher prices for consumers.

Related: Manage Inflation Expectations With ‘RINF’ ETF

The latest inflation data comes as Treasury yields have been climbing in addition to rising interest rates, causing investors to flock to shorter-duration debt issues as opposed to those with longer maturities.

"We've seen general selling in medium to long duration bonds for a few weeks with clients going into cash, equities, and very short duration ETFs," said Joseph LaGrasta, ETF Sales & Trading at Virtu Financial.

Playing the Short Game

With the short-term rate adjustments being instituted by the Federal Reserve, investors can limit exposure to long-term debt issues and focus on maturity profiles. An example would be the  SPDR Portfolio Short Term Corp Bd ETF (SPSB) , which seeks to provide investment results that correspond to the performance of the Bloomberg Barclays U.S. 1-3 Year Corporate Bond Index.

SPSB invests at least 80 percent of its total assets in securities designed to measure the performance of the short-termed U.S. corporate bond market. Ideally, shorter-term bond issues with maturities of three to four years are ideal to minimize duration exposure should the bull market enter a correction phase.

"To mitigate the impact of rising short-term rates, investors can consider targeting specific duration profiles," said Matthew Bartolini, Head of SPDR Americas Research. "In the past year, targeting the 1-3 year corporate maturity band vs. the 1-5 year band would have delivered 60 basis points of outperformance. Yields are comparable (3.31% vs. 3.41%), but the 1-3 year space has almost one year less of duration."

Another short-term bond ETF option is the iShares 1-3 Year Credit Bond ETF (CSJ) , which tracks the investment results of the Bloomberg Barclays U.S. 1-3 Year Credit Bond Index where 90 percent of its assets will be allocated towards a mix of investment-grade corporate debt and sovereign, supranational, local authority, and non-U.S. agency bonds that are U.S. dollar-denominated and have a remaining maturity of greater than one year and less than or equal to three years–this shorter duration is beneficial during recessionary environments.

With more rate hikes expected to come in the Fed's current monetary policy agenda, Bartolini identifies the pressure on bond portfolios this has been effectuating irrespective of whether they are long or short duration. In addition, fiscal policy has also been a major factor in bond performance.

"Longer or intermediate bond funds have been affected by the Fed’s monetary policy actions. However, fiscal policy has also had an impact," said Bartolini. "The 10-year spiked at the beginning of the year once the tax cuts were passed and debt issuance by the US government increased to fund the cuts, expanding the already high budget deficit. These actions have had an impact on inflation and longer term rates, sending them higher and bonds lower, leading to losses on particularly bond funds sensitive to those key rate durations."

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