Fixed-income investors are searching far and wide to adapt their portfolios to a rising rate environment.
Perhaps surprisingly, U.S. Treasury yields have not jumped as much as previously anticipated this year. While the Federal Reserve raised interest rates in March, possibly setting the stage for more rate hikes later this year, the central bank sounded a somewhat dovish tone.
Plus, with stocks tumbling the past few days, some market observers expecting volatility to return and still slow economic growth, the Fed may not have the room to boost borrowing costs as rapidly as previously expected.
That scenario has been a boon for exchange traded funds such as the iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT). There are some obvious fundamental factors that bode well for U.S. debt ETFs, namely a slew of negative interest rate policies throughout the developed world, which make the low yields on U.S. bonds look all the more attractive.
“Still, the simple truth is that there is not much evidence that the economy is surging. Yes, job growth remains strong and consumers and small businesses optimistic. However, outside of the labor market actual economic activity remains modest. Adjusted retail sales are growing at roughly 4.5% year-over-year, in-line with the post-crisis average. While investment activity improved in Q1 and manufacturing is crawling back from its recession, industrial production remains muted,” according to a recent BlackRock note.
Moreover, U.S. fixed-income market may find further support from overseas demand, especially with international bonds offering paltry yields. The low yields in overseas markets have also helped support U.S. Treasuries as an attractive alternative source of yield for foreign investors.
“German 10-year yields are still below 0.50%, while similar maturities in Japan and Switzerland yield 0.03% and -0.09% respectively. With the exception of Australia and New Zealand, the U.S. has just about the highest long-term rates in the developed world. For many foreign investors, the U.S. remains an attractive place to invest, keeping bond prices high and yields suppressed,” according to BlackRock.
TLT has been a popular Treasury bond play for yield generation over the past few years after the Federal Reserve implemented near-zero interest rates and a robust bond purchasing program. However, TLT comes with a duration of over 17 years – a 1% increase in interest rates would translate to about a 17% decline in the fund’s price.
For more information on the fixed-income space, visit our bond ETFs category.