While many anticipate bonds and debt-related exchange traded funds will likely fall as rates rise, longer-term Treasuries may outpace short-term bonds and corporate debt in a rising rate environment.
The iShares 1-3 Year Treasury Bond ETF (NYSEArca: SHY), which has a 1.85 year duration and a 0.77% 30-day SEC yield, has gained 0.7% year-to-date. Meanwhile, the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF), which has a 7.64 year effective duration and a 2.02% 30-day SEC yield, gained 2.7% so far this year. [How Rising Rates Affect Bond ETFs]
Looking at historical data, every time the Federal Reserve hiked rates over the past four decades, Treasuries with longer maturities have outperformed short-term debt and even exceeded corporate bonds in the first year of tightening as higher rates depressed inflation and kept the economy from overheating, Bloomberg reports. Treasuries only underperformed once in the period.
In the year ahead, many don’t believe the Fed will move too quickly or aggressively, so interest rates may move higher at a leisurely pace as inflation remains low, the global economic outlook seems tepid and the U.S. economy expands at its weakest pace in decades.
Consequently, JPMorgan Chase & Co. recently found that investors were more bullish on Treasuries at any time since 2013. The preference for long-term Treasuries isn’t something new. Over the last five rate hike periods, bond traders have consistently favored long-term Treasuries as the yield curve flattened.
“This is not the start of a bear market in Treasuries,” David Tan, the head of rates at JPMorgan Asset Management, told Bloomberg. Tan is currently “overweight” 30-year U.S. bonds and “underweight” five-year notes.