Long-term U.S. treasury yields have been on the uptrend lately. Benchmark U.S. Treasury yields were 4.26% on Nov. 5, up from 3.74% recorded on Oct.1. Billionaire investor Ray Dalio, founder of Bridgewater Associates, expressed significant concerns about the U.S. political landscape, particularly post-election uncertainties, during the Future Investment Initiative conference in Saudi Arabia, as quoted on CNBC. Dalio is concerned about the U.S. political scenario, its debt problem and the potential rise in Treasury yields.
Dalio pointed out that Republican candidate Donald Trump is “a lot more capitalist” compared to Democratic candidate Kamala Harris. Hence, Trump’s policies are more favorable for domestic capital markets. Despite this, Dalio expressed concerns over the looming fiscal challenges, predicting significant deficits regardless of which party is in power.
Investors should note that Treasury yields rose in overnight trading as investors weighed the early results from the tight presidential race between Vice President Kamala Harris and former President Donald Trump. The 10-year Treasury yield jumped 15 basis points to trade at 4.435%, hitting its highest level since July 2. The yield on the 2-year Treasury was up by 8 basis points at 4.278%, reaching its highest level since July 31.
Treasury Yields to Rise Ahead?
Dalio raised alarms about the U.S. debt situation, describing it as “a real debt problem.” He pointed to the risks posed by an increasing supply of U.S. Treasuries, noting that approximately one-third of these are held by foreign entities, creating a supply-demand imbalance with potential upside risks for investors.
Fed Facing a Complex Environment
As Federal Reserve Chair Jerome Powell and his colleagues meet this week, they will be facing a much more complicated landscape compared to just two months ago. A historic increase in long-term Treasury yields since the central bank’s significant rate cut on Sept. 18 has added to their challenges.
What Caused the Spike in Yields?
A significant factor behind this rise is what has been termed "Trump trades" — a market reaction where investors sell Treasuries anticipating that former president Donald Trump may return to office with relaxed fiscal policies. Additionally, strong U.S. economic growth and persistently high inflation have augmented skepticism about the Fed’s decision to begin easing with a 50-basis point cut.
Fed's Control Over Yield Curve
While the Fed’s primary policy tool is the overnight interbank rate, there is a broad belief that it can control longer-term borrowing costs through a combination of strategies, such as quantitative easing, forward guidance, and programs like Operation Twist. Should market confidence in this mode of control wear away, it could create a problematic scenario for the U.S. central bank.
Andy Constan, chief executive officer and chief investment officer at Damped Spring, posits that, in this scenario, markets could see the 10-year and 30-year yields spike above 5.50% (up from 4.26% now) and 6% (up from 4.44% now), respectively. The 'term premium' could jump to as high as 100 bps, inflation expectations could be de-anchored, and the S&P 500's 12-month forward P/E ratio could fall to 16 from 22 today, as quoted on Reuters.
ETF Strategies to Follow
Given this, investors must be interested in finding out all possible strategies to weather a rise in interest rates. For them, below we highlight a few exchange-traded fund (ETF) investing tricks that could gift investors with gains in a rising rate environment.
Tap Senior Loan ETFs
Senior loans are floating rate instruments thus providing protection from rising interest rates. This is because senior loans usually have rates set at a specific level above LIBOR and are reset periodically which help in eliminating interest rate risk. Further, as the securities are senior to other forms of debt or equity, senior bank loans offer lower default risks even after belonging to the junk bond space.
Virtus Seix Senior Loan ETF SEIX, which yields about 8.48% annually and Invesco Senior Loan ETF BKLN, which yields 8.71% annually are good picks here.
Play Floating Rate Bond ETFs
The floating rate bond has been an area to watch lately amid rising rate environment. Floating rate bonds are investment grade and do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of issuers.
Since the coupons of these bonds are adjusted periodically, these are less sensitive to an increase in rates compared to the traditional bonds. Unlike fixed-coupon bonds, these do not lose value when the rates go up, making the bonds ideal for protecting investors against capital erosion in a rising rate environment.
Tap Senior Loan ETFs
Senior loans are floating rate instruments thus providing protection from rising interest rates. This is because senior loans usually have rates set at a specific level above LIBOR and are reset periodically which help in eliminating interest rate risk. Further, as the securities are senior to other forms of debt or equity, senior bank loans offer lower default risks even after belonging to the junk bond space.
Virtus Seix Senior Loan ETF (SEIX), which yields about 8.78% annually and Invesco Senior Loan ETF BKLN , which yields 8.62% annually are good picks here.
Play Floating Rate Bond ETFs
The floating rate bond has been an area to watch lately amid rising rate environment. Floating rate bonds are investment grade and do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of issuers.
Since the coupons of these bonds are adjusted periodically, these are less sensitive to an increase in rates compared to the traditional bonds. Unlike fixed-coupon bonds, these do not lose value when the rates go up, making the bonds ideal for protecting investors against capital erosion in a rising rate environment.
iShares Floating Rate Bond ETF FLOT (yields 5.93% annually) and iShares Treasury Floating Rate Bond ETF TFLO (yields 5.35% annually) are two examples in this category.
Time for Cash-Like ETFs?
We believe cash and short-dated fixed income may play a greater role in adding stability to a portfolio. This is especially true given that the Fed may not cut rates faster and short-term bond yields may stay high for a little longer. That would result in a similar rate for cash-like assets such as money-market funds.
Investing options include JPMorgan UltraShort Income ETF JPST (yields 5.27% annually), Invesco Global ex-US High Yield Corporate Bond ETF PGHY (yields 7.51% annually), and Fidelity Low Duration Bond Factor ETF FLDR (yields 5.59% annually). Such short-term bond ETFs also have lower interest rate sensitivity.
Hedge Rising Rates With Niche ETFs
There are some niche ETFs that guard against rising rates. These ETF options are: Simplify Interest Rate Hedge ETF PFIX (yields 8.90% annually), Global X Interest Rate Hedge ETF RATE (yields 3.22% annually) and Foliobeyond Rising Rates ETF RISR (yields 7.03% annually).
Go Short with Rate-Sensitive Sectors
Needless to say, sectors that perform well in a low-interest rate environment and offer higher yield, may falter when rates rise. Since real estate and utilities are such sectors, it is better to go for inverse REIT or utility ETFs. ProShares UltraShort Real Estate SRS, ProShares Short Real Estate REK and ProShares UltraShort Utilities SDP are such inverse ETFs that could be wining bets in a rising rate environment.
Short U.S. Treasuries
Plus, shorting U.S. treasuries is also a great option in this type of a volatile environment. The picks include ProShares UltraShort 20+ Year Treasury ETF TBT, Direxion Daily 20+ Year Treasury Bear 3x Shares TMV and ProShares UltraShort 7-10 Year Treasury PST.
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Get it free >>ProShares UltraShort 20+ Year Treasury (TBT): ETF Research Reports
ProShares UltraShort 7-10 Year Treasury (PST): ETF Research Reports
Direxion Daily 20+ Year Treasury Bear 3X Shares (TMV): ETF Research Reports
iShares Floating Rate Bond ETF (FLOT): ETF Research Reports
Invesco Senior Loan ETF (BKLN): ETF Research Reports
iShares Treasury Floating Rate Bond ETF (TFLO): ETF Research Reports
Invesco Global ex-US High Yield Corporate Bond ETF (PGHY): ETF Research Reports
Fidelity Low Duration Bond Factor ETF (FLDR): ETF Research Reports
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
