With the Omicron variant and inflation headlining the capital market news, it’s easy to forget that a flattening yield curve also poses a threat, but hedge funds are betting that long-term yields will rise.

With the Federal Reserve expected to raise interest rates in 2022, bond investors could be avoiding short-term bonds, causing yields to spike. A flat yield curve could portend to investors feeling skepticism regarding the macroeconomic outlook.

As mentioned, there’s reason for pessimism. The Omicron variant still remains a wild card in the capital markets heading into 2022, while inflation could erode fixed income yields in the short term.

However, hedge funds are betting on a brighter outlook. Many think that eventually the long end of the yield curve will rise, effectively putting the kibosh on the flattening yield curve.

“Some hedge funds are betting that pricing in the bond market that reflects pessimism about the US economy will not last, remaining in a trade that has cost some of the biggest players billions of dollars this year,” the Financial Times notes.

“The Federal Reserve’s recent pivot towards a more aggressive strategy to fight elevated inflation has flattened the so-called yield curve, a signal that some investors anticipate that the US central bank’s policy tightening could eventually crimp longer-term economic growth,” the Financial Times says further.

Getting Long-Term Bond Exposure

Yield-hungry investors looking for a long-term option in terms of duration can check out an exchange traded fund (ETF) like the Vanguard Long-Term Bond Index Fund ETF Shares (BLV). As of December 31, 2021, the fund has a 30-day SEC yield of 2.6%.

With an average debt duration of 16 years in its holdings, BLV seeks to track the performance of the Bloomberg U.S. Long Government/Credit Float Adjusted Index. This index includes all medium and larger issues of U.S. government, investment-grade corporate, and investment-grade international dollar-denominated bonds that have maturities of greater than 10 years and are publicly issued.

As such, BLV can draw from a variety of options when it comes to bond investments. As mentioned, the common denominator is that the fund sticks to higher duration with debt holdings that exceed a decade.

Product summary per the Vanguard website:

  • Seeks to track the performance of the Bloomberg U.S. Long Government/Credit Float Adjusted Index.
  • Exchange-traded share class.
  • Passively managed using index sampling.
  • Diversified exposure to the long-term, investment-grade U.S. bond market.
  • Provides high current income with high credit quality.

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