What to Watch As Bond ETF Yields Rise

January 13th at 1:00pm by Tom Lydon

110_F_726603_NdVfphjklmwSb7VfBLUfggDrN2Q4bc Bond yields are on the rise, which doesn’t necessarily have exchange traded fund (ETF) investors whooping it up. That’s because rising yields not only send prices lower, but they can be a harbinger of other things, such as impending inflation.

As Allen Robinson for Global Investors points out, a rise in yield often precedes a Treasury announcement as investors anticipate that the increase in bond supply will cause prices to fall and yields to rise. These increasing rates also signal that investors are growing increasingly concerned about inflation. [Why it's time to look at bond ETFs differently.]

David Bogoslaw for BusinessWeek gives investors a few clues about what they should be watching amid the conflicting views about inflation:

  • Asset bubbles and consumer prices: Many strategists believe the economy has too much slack for any meaningful rise in consumer prices in 2010. It’s possible for asset bubbles to form even when consumer prices are stable or in decline. [Are there clues in the yield curve?]
  • 5-Year TIPS: Investors who are still worried about inflation reaching 3% to 5% down the road to wait for a cheaper entry point into TIPS, which could occur if CPI figures start to come down in the months ahead. With inflation pressures so benign, don’t expect the Fed to start raising rates until the fourth quarter of 2010, says one strategist.
  • Withdrawing the stimulus: If inflation is rising at a slower pace this year, but investors are becoming more concerned about inflation over the medium term, TIPS can still do very well relative to nominal Treasuries. By pricing 10-year TIPS at 2.40%, just below the baseline inflation rate of 2.5% expected over the coming 10 years, the market is saying it expects the Fed to get its timing right and withdraw the fiscal and monetary stimulus before they lead to inflation.
  • No Wage Inflation: Unemployment is expected to stay high over the next few years, meaning wages could become stagnant. Investors who live on most of the total return in their fixed-income portfolios this year will come from the coupon interest on the bonds they own.
  • Protectionism grows stronger: Economic conflicts over trade deficits could spark a new wave of protectionism – a bigger risk than military conflicts. But that would lead to deflation, not inflation, because the unavailability of certain resources would hamper economic expansion.
  • Emerging markets look inviting: Opportunity for higher returns in corporate bonds in the more robust emerging markets will abound, where credit spreads have contracted substantially but there’s still room for further contraction.

For more stories about bonds, visit our bond category.

  • iShares Barclays TIPs Bond ETF (NYSEArca: TIP)

  • SPDR Barclays Capital TIPS (NYSEArca: IPE)

  • PIMCO 1-5 Year U.S. TIPS (NYSEArca: STPZ)

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.