With interest rate expectations on the rise ahead of the Federal Reserve meeting next week, fixed-income investors can ride the jump in longer-term government yields through a so-called Treasury steepener exchange traded note.
Since the end of August, 10-year Treasury note yields have gained 28 basis points to 2.61%. Meanwhile, the iPath US Treasury Steepener ETN (NYSEArca: STPP) gained 4.6%.
The specialized bond ETN tracks the steeping yield curve in the Treasuries market. The steepening curve reflects the rising spread between yields on short-term and long-term bonds. When the curve flattens, the gap is narrowing. STPP performs well when the yield curve is steepening.
Specifically, STPP tracks the returns of a notional investment in a weighted long position in two-year Treasury futures and a weighted short position in relation to 10-year Treasury futures contracts. As the markets expect interest rates to rise, longer-dated Treasury bond yields rise and their face value dips. Since late August, the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF), which tracks intermediate Treasuries with a 7.67 year duration, has decreased 2.1%. [Treasury ETF Volatility in Advance of Fed Tightening]
The yield gap between the two- and 10-year notes steepened to 2.05 percentage points Friday, the most since August 1.
More observers are anticipating the Fed to hike rates earlier than anticipated. Bank of America Merrill Lynch economists believe the Fed will begin hiking rates in June 2015 and remove its forward guidance on rates remaining low for a “considerable time,” CNBC reports.