For Upside In Fixed Income, Seek Intermediate-Term Treasuries

Last year was one of the worst on record for aggregate bond strategies. One of the primary culprits behind that downside was U.S. government debt, particularly longer-dated bonds. Fortunately, the Federal Reserve’s 2023 rate hikes were largely priced into the bond market and inflation is easing. That gives investors seeking fixed income upside some motivation to revisit longer-dated ETFs, including the Vanguard Intermediate-Term Treasury ETF (VGIT).

VGIT, which follows the Spliced Bloomberg U.S. Treasury 3-10 Year Index I, turns 14 years old in November. The Vanguard ETF is among those government bonds ETFs showing signs of life in 2023. It has a year-to-date gain of 3.65%. A 30-day SEC yield of 3.53% is nothing to scoff at, either, particularly when considering credit risk is minimal with VGIT.

The fund is higher by 0.81% over the past month, indicating bond market participants expect the Biden Administration and Congress will find some common ground on the debt ceiling debate, which help the U.S. avert a credit default.

Other VGIT Advantages

As noted above, one of the primary reasons bonds tumbled last year was due to the Fed raising interest rate. The biggest impetus for those rate hikes was, historically, high inflation. Perhaps providing support for the VGIT thesis this year is the point that inflation is easing.

“Well, inflation has started to moderate both in terms of consumer prices and wages. And in response, central banks have become less aggressive in their recent policy maneuvering. Investors have also benefited from the clarity on the speed with which central banks have moved and how fast they may move in the future,” noted Matthew Hornbach, Global Head of Macro Strategy for Morgan Stanley.” This would seem like good news for government bond returns, and so far it has been. However, at the same time, investor nerves remain frayed, even if less so than last year.”

VGIT, which holds 110 bonds, has an average duration of 5.2 years. That’s not alarmingly high, but it’s not ultra-short term, either. Said another way, there is some rate risk with intermediate-term bonds and the related ETFs. On that note, it appears the Federal Reserve is unlikely to boost borrowing costs again this year and that could provide some runway for downside for Treasury yields. That would benefit VGIT.

Additionally, intermediate-term bonds historically are the least correlated to stocks, indicating VGIT can have positive diversification benefits within investor portfolios. The ETF offers other potential benefits, too.

“Putting it all together, the higher yields available in the government bond markets and the increasing risk to economic activity, including those from the lagged effects of monetary policy tightening, leave us hopeful on the future returns of the asset class,” concluded Hornbach.

For more news, information, and analysis, visit the Fixed Income Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.