Treasury yields are beginning to tick higher after the bout of volatility sent investors to safety. While rates haven’t surged, Treasury bond exchange traded fund investors should prepare for a rising rate environment.
“Bond investors and traders should consider preparing for the next wave of volatility, and the potential for rising yields should the economy improve, and easing end,” according to a Direxion note.
For instance, long-term, 30-year Treasury bonds could lose 16% if interest rates rise 1%, Direxion said. The iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT), which has a weighted average maturity of 27.3 years and an effective duration of 16.32 years, could see price declines of as much as 16.3%, given a 1% rise in rates.
An ETF’s duration provides a measure of sensitivity to changes in interest rates, so a longer duration translates to a greater negative impact if rates do rise.
Consequently, bond investors may consider shifting to shorter duration options, such as the iShares 1-3 Year Treasury Bond ETF (NYSEArca: SHY), which has a 1.86 year duration; iShares 3-7 Year Treasury Bond ETF (NYSEArca: IEI), which has a 4.47 year duration; or iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF), which has a 7.46 year duration.
Alternatively, inverse ETFs, or strategies that take the short side of a market, could act as a more aggressive hedge against rising rates and falling bond prices.
For example, the ProShares Short 20+ Year Treasury (NYSEArca: TBF) and Direxion Daily 20+ Year Treasury Bear 1x Shares (NYSEArca: TYBS) both try to produce the inverse, or -100%, return of long-term Treasuries. [Inverse Treasury ETFs Help Hedge Against Rising Rates]
For those looking for a supercharged bet against Treasury prices, the ProShares UltraShort 20+ Year Treasury (NYSEArca: TBT) provides a -200% return of long-term Treasuries. TBT is up 24.1% year-to-date. The ProShares UltraPro Short 20+ Year Treasury (NYSEArca: TTT) and Direxion Daily 20-Year Treasury Bear 3X (NYSEArca: TMV) reflect -300% return on long-term Treasuries.
Looking at intermediate-term, inverse Treasury bond options, the the ProShares Short 7-10 Year Treasury (NYSEArca: TBX) tries to track the inverse, or -100%, daily performance of the Barclays U.S. 7-10 Year Treasury Bond Index. Leveraged options include the ProShares UltraShort 7-10 Year Treasury (NYSEArca: PST) tries to track two times the inverse, or -200%, daily performance of the Barclays U.S. 7-10 Year Treasury Bond Index, and the Direxion 7-10 year Treasury Bear 3x (NYSEArca: TYO), which takes a triple inverse, or -300%, position. [Inverse Treasury ETFs Thrive as Rates Soar]
Traders considering these products should be aware that the inverse and leveraged products try to achieve their objective on a daily basis, and due to compounding of daily returns, the performance of the ETFs may diverge from the target return over extended periods, especially during volatile market conditions.
“When it comes to leveraged fund products that track daily results, their returns over time are the product of a series of daily returns,” according to Direxion. “They are not the fund’s leverage point multiplied by the cumulative return of the index for periods greater than a day. During periods of high volatility where markets lack a directional trend, returns can be impacted in a negative way should the funds be held for long periods.”
For more information on Treasuries, visit our Treasury bonds category.
Max Chen contributed to this article.