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Treasury Bond ETFs in Focus on Rising Rate Hike Prospects

Strong domestic economic data and comments from some of the Fed officials in recent times have raised speculation that the central bank may consider hiking key interest rates in the near future.  Following the rising rate hike possibilities, U.S. treasury bonds yields, which were lately suffering from low-yields, witnessed a rebound. However, the sustainability of the trend will largely depend on the rate hike path in the near future.

Increasing Chances of a Rate Hike

Recent comments from some of the Fed officials raised speculations that a hike is likely by the end of this year, which in turn boosted yields on treasury bonds. Among others, Fed’s vice chair Stanley Fisher hinted that there is a possibility of a rate hike this year. He provided an encouraging assessment of the economy’s current strength, with the job market nearing full employment. He also stated that the inflation rate is “within hailing distance of 2 percent” as Fed’s preferred price benchmark minus food and energy cost is currently at 1.6% (read: Hawkish Fed Vice Chairman Adds Strength to These ETFs).

Moreover, the New York Fed President William Dudley indicated that a hike in September’s policy meeting is “possible.” He also added: “We're edging closer towards the point in time where it'll be appropriate to raise interest rates further.” Separately, the Atlanta Fed President Dennis Lockhart said that the current situation is favorable for a minimum of one rate increase by the end of this year. According to him, “at least one increase of the policy rate could be appropriate later this year” as the economy is poised to witness a strong rebound in the third quarter. The labor market is speculated to experience the positive trend for a longer period of time (read: ETFs to Watch as Fed Members Indicate Rate Hike in September).

In this scenario, investors are eagerly waiting to find concrete clues to the rate hike path from Fed Chair Janet Yellen’s speech in Jackson Hole, WY on Friday. Though market believes that a September hike is unlikely, investors’ anticipation of a hike by the end of this year is gradually increasing.

Will Treasury Yields Rebound?

Yields on the U.S. treasury bonds fell significantly following June 23’s Brexit referendum as a rise in uncertainty level led investors to allocate their assets in safer treasury bonds. However, the recent speculations led the yields to rebound to some extent. Interest rate has an inverse relationship with bond prices, which in turn is negatively related with bond yields. That means if interest rates rise, bond yields also move in the same direction.

This the reason why yields on 3-year, 5-year and 10-year treasury bonds rose 10.3%, 8.5% and 2.6% to 0.86%, 1.15% and 1.55% over the month-to-date period, respectively (as of Aug 23). Also, yields on 20-year treasury bonds increased 2.2 percentage point to 1.88% during the same time frame. These improvements are likely to get an additional boost if Yellen’s speech on Friday echoes the comments of other Fed officials. However, some analysts are predicting that the Fed chief may limit herself from providing any concrete clue regarding the timing of the rate hike, which may again lead to more uncertainty.

Treasury Bond ETFs To Watch

In this backdrop, ETFs that have significant exposure to treasury bonds are likely to remain on investors’ radar in the coming days. It is also known that yields on treasury bonds of shorter maturity are poised to be more interest-sensitive compared to those with longer maturity periods. Thus, performance of short-term treasury bond ETFs including iShares 1-3 Year Treasury Bond SHY, Schwab Short-Term US Treasury ETF SCHO and Vanguard Short-Term Government Bond ETF VGSH will be closely watched in the days ahead.

Over the month-to-date frame, SHY, SCHO and VGSH registered inflows of $195.9 million, $76.2 million and $15.3 million, respectively, indicating that these ETFs have attracted significant investor attention in recent times.

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ISHARS-1-3YTB (SHY): ETF Research Reports
VANGD-ST GOV BD (VGSH): ETF Research Reports
SCHWAB-US ST TR (SCHO): ETF Research Reports
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