Treasury yields are rising in the low end of the yield-curve as investors anticipate the eventual end to the Fed’s monthly bond purchasing program. Consequently, short-term bond and related exchange traded fund prices could begin to decline.
Before the U.S. sells $30 billion of 3-year Treasury notes, investors pushed up 3-year note yields to 0.81%, the highest since September 10 when yields were at 0.897%, Bloomberg reports. The yields on 3-year notes currently hover around 0.77%.
Bond prices have an inverse relationship to yields, so a rising yield corresponds to falling prices.
Treasury prices have been weakening after the latest U.S. economic data revealed employers are adding more jobs than expected last month, which fueled speculation that the Fed would continue tapering quantitative easing.
“For some at the shorter end, any expectation that the Fed would slow tapering has now been reduced to zero,” Dan Greenhaus, chief global strategist, said in the article. “What you’re seeing at the short end is a push to higher yields as that expectation is priced out of the market.”
Fed Chair Janet Yellen has stated that the Federal Reserve’s bond purchasing program will likely end in fall if the economy is in line with expectations. The Fed has already reduced QE by $20 billion to $65 billion.
Quantitative easing was originally intended to help lower short-term interest rates. As the program ends, yields on the low end of the curve will begin to rise. Consequently, short-term Treasury bond investors may see falling prices in ETFs like the iShares 1-3 Year Treasury Bond ETF (NYSEArca: SHY), Schwab Short-Term U.S. Treasury ETF (NYSEArca: SCHO), Vanguard Short-Term Government Bond ETF (NYSEArca: VGSH) and PIMCO 1-3 Year U.S. Treasury Index Fund (NYSEArca: TUZ). [BlackRock: Who uses Fixed Income ETFs? The Answer may Surprise You]
The ETFs all track Treasury bonds with maturities between one and three years. Given the short duration and yields of the four options, investors have used the short-term Treasury bond ETFs as a substitutes for cash. However, there is still some rate risk as the funds have an effective duration of about 1.9 years, which means that a 1% rise in interest rates could translate to a 1.9% decline in the bond ETFs’ prices. [Bond ETFs Help Investors Navigate Changing Market Tides]
For more information on Treasuries, visit our Treasury bonds category.