Central banks around the world are getting aggressive in an effort to curb soaring inflation. On June 15 the Federal Reserve raised the benchmark federal funds rate by 75 bps, bringing the target range to between 1.50% and 1.75%. The following day, the Bank of England agreed to raise rates for the fifth consecutive time in a row, increasing the Bank Rate to 1.25%.
These actions will have significant effect on fixed income markets. The short end of the yield curve is particularly sensitive to the actions of central banks. Due to the inverse relationship between bond yields and price, rising rates will be a headwind for bond returns. But there are some areas of the bond market that are less sensitive to interest rates and can offer protection for your fixed income allocation.
Short Duration ETFs
Duration is the measure of a bond’s sensitivity to interest rates, so it follows that short duration bonds are better suited for the rising rate environment we are currently in. Short duration ETFs target an overall duration of five years or less.
Using the Trackinsight ETF Screener to search for U.S. listed short duration ETFs shows several options available to investors. The Schwab Short-Term U.S. Treasury ETF (SCHO) is one of the highest-rated short-term ETFs available, tracking an index of Treasury securities. Meanwhile, for those who want corporate bond exposure, an ETF like the SPDR Portfolio Short Term Corporate Bond ETF (SPSB) that tracks an index of investment-grade corporate bonds could be used.
Both ETFs have significantly outperformed the iShares Core U.S. Aggregate Bond ETF (AGG) this year. Through market close on June 15, SCHO has fallen by -3.6% this year while SPSB has fallen by -3.9%. This is compared to an -11.5% drop for the broad-based AGG, which has a duration of. 6.5 years.
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