Treasury bonds and related exchange traded funds look more attractive on declining inflation expectations as sagging commodity prices and a strengthening U.S. dollar helped improve the real rate of return.
Over the past month, the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) gained 1.5%, Schwab Intermediate-Term U.S. Treasury ETF (NYSEArca: SCHR) added 0.8% and Vanguard Intermediate-Term Government Bond ETF (NYSEArca: VGIT) rose 0.8%.
Meanwhile, the iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT) jumped 5.1%, PIMCO 25+ Year Zero Coupon US Treasury (NYSEArca: ZROZ) surged 8.9% and Vanguard Extended Duration Treasury ETF (NYSEArca: EDV) advanced 7.9% over the past month.
The diminished inflation expectations has bolstered demand for long-term maturities. The spread between two- and 30-year securities dipped for a fourth day after contracting to as little as 208 basis points Monday, the least since April 28, Bloomberg reports.
Long-term Treasuries have strengthened and yields dipped on the continued decline in oil prices helped push down inflationary pressures. Meanwhile, short-term Treasury yields have been anchored as speculators bet on a slow interest rate hike from the Federal Reserve.
U.S. “break-even” rates, a measure of inflation expectations from the difference in yields of nominal and inflation-protected bonds, have rapidly declined in recent weeks, revealing investors’ expectations that the Fed will be unable to retain its inflation target for the foreseeable future, the Financial Times reports.
Specifically, the two-year break-even rate fell to 0.41% Monday, compared to over 1% in mid-July. The five-year break-even rate was 1.23%, the 10-year rate was 1.59% and the 30-year rate stood at 1.79%. The lower inflation makes Treasury bonds more attractive to fixed-income investors as the real yield, or adjusted nominal return to compensate for inflation, has become more attractive.
“There’s a nice trend downwards for U.S. Treasury yields,” Birgit Figge, a fixed-income strategist at DZ Bank AG, told Bloomberg. “The inflation expectations are very low at the moment. If inflation stays low, the Fed doesn’t need to raise in September.”
Yields on benchmark 10-year Treasury notes are hovering around 2.2%. Two-year not yields were at 0.72% and yields on 30-year Treasuries were at 2.87%.
The futures market reveals a 44% chance the Fed will hike benchmark interest rates at its September 16, 17 meeting based on assumptions that the effective fund rate will average 0.375%. The key rate has hovered in a range of zero to 0.25% since December 2008.
“I wouldn’t be surprised to see 10- or 30-year Treasuries outperform a bit more looking at how oil prices are doing,” Jun Kato, senior fund manager at Shinkin Asset Management Co., told Bloomberg. “Investors are seeing a considerably slow pace of Fed rate rises after the first one likely next month, and even the possibility of no further hikes for quite some time.”
Treasury bonds, though, weakened Tuesday, following the improved housing data, which made boost the Fed’s case for raising rates this year.
For more information on the Treasuries market, visit our Treasury bonds category.
Max Chen contributed to this article.