Contrary to what many expected, Treasury bond exchange traded funds were among the best performers after the Federal Reserve raised benchmark interest rates for the third time in six months.
Among the top performing ETFs, the iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT), PIMCO 25+ Year Zero Coupon US Treasury (NYSEArca: ZROZ) and Vanguard Extended Duration Treasury ETF (NYSEArca: EDV) popped, following the rate hike decision, as yields on 30-day Treasury notes dipped to 2.783% Wednesday, their lowest level since the U.S. presidential election. Meanwhile, yields on benchmark 10-year notes slipped to 2.138% after briefly touching 2.1% earlier in the session.
Weighing on Treasury yields and bolstering bond prices, the tepid inflation numbers outweighed traders’ concerns over the Fed’s announced quarter-point rate hike and plans to reduce its balance sheet this year.
The five-year, five-year forwards rates, one of the ways the Fed gauges inflation expectations, recently dipped to 1.83%, which suggested that investors agreed with the Fed’s updated inflation outlook, reports Sunny Oh for MarketWatch.
“The market is taking this as a little more hawkish statement. It looks like as it stands, policy normalization is still on track, but [the Fed] are watching inflation developments,” Jennifer Lee, senior economist at BMO Capital Markets, told MarketWatch.
The inflation numbers support the bond outlook as investors would generate a greater real yield, or yield after inflation, in a low inflation environment. On the other hand, a rise in inflation would erode the value of bond’s fixed interest payments.
Moreover, lackluster economic data, specifically, the Commerce Department’s dip in retail sales data in May, also weighed on market sentiment.
Consequently, given the weak economic and inflation data points, observers are questioning whether or not the Fed can maintain its current level of monetary tightening.
“It could feel like a bus that never shows up if you’re waiting for yields to spike higher. If you’ve been sitting in cash and waiting for yields to rise before getting back to your strategic allocation to fixed income, you may want to start dollar cost averaging toward your target,” Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds Management, said, according to ETF.com.
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