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Leveraged Bond ETFs For A Shifting Fed Outlook

Amid increased market volatility and concerns about the goings on within the Trump Administration, expectations are shifting regarding the Federal Reserve's ability to move forward with a June interest rate hike or more rate increases at all this year.

As it is, the Fed sounded a surprisingly dovish tone when it raised rates in March, which weighed on assets positively correlated to higher interest rates, including financial services stocks and the relevant exchange traded funds.

Of course, no interest rate increases should be good for Treasury prices, meaning lower yields could be forthcoming. That could translate to good news for scores of fixed income ETFs, including some leveraged plays such as the Direxion Daily 7-10 Year Treasury Bull 3X Shares (NYSE: TYD) and the Direxion Daily 20+ Year Treasury Bull 3X Shares (NYSE: TMF).

TMF attempts to deliver triple the daily returns of the ICE U.S. Treasury 20+ Year Bond Index. That index “is a market value weighted index that includes publicly issued U.S. Treasury securities that have a remaining maturity of greater than 20 years. Eligible securities must be fixed rate, denominated in U.S. dollars, and have $300 million or more of outstanding face value, excluding amounts held by the Federal Reserve. Securities excluded from the Index are zero-coupon STRIPS, inflation linked securities, floating rate notes, cash management and Treasury bills, and any government agency debt issued with or without a government guarantee,” according to Direxion.

TYD seeks to deliver triple the daily performance of the ICE U.S. Treasury 7-10 Year Bond Index, which is also a cap-weighted benchmark, according to Direxion.

“Because interest rates are implemented as a measure to mitigate inflation in times of economic growth, the value of low-rate bonds are further lessened as investors weigh their portfolios with more reactive securities,” said Direxion in a recent research piece. “These forces have played out in a variety of ways since late 2016, particularly in the wake of the post-election market rally which saw ICE U.S. Treasury 7-10 and 20+ Year Bond Indexes fall sharply, the former by 6.2 percent and the latter by 9.8 percent, by December 16.”

Recent flows data suggest traders have been bearish on government bonds, perhaps expecting a June rate hike. For example, TMF's bearish counterpart, the Direxion Daily 20+ Year Treasury Bear 3X Shares (NYSE: TMV), has averaged daily inflows of $537,500 over the past month, according to issuer data.

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