With the U.S. Federal Reserve recently standing pat on interest rate hikes, bets on rate cuts are dissipating as the data-dependent central bank seeks more confirmation before loosening monetary policy. In the meantime, it’s helping to fuel spikes in short-term yields.
There was much optimism heading into 2024 that rate cuts would eventually come, but now the capital markets are having to exercise a degree of patience. Swift and frequent rate cuts may very well turn into a more slow-paced, measured strategy by the Fed. That said, traders may be scaling back on their rate cut bets, which may be pushing short-term yields higher.
“Combined with significant new Treasury and corporate debt issuance, the unwind of rate cut bets has contributed to short-end bond yields pushing aggressively higher, seeing two-year yields threaten to break above 4.5%,” a Forex.com report noted.
Short-term bond funds were at their peak popularity during the Fed’s aggressive rate hikes the past couple of years. With the expectation of cuts to come, they lost a bit of their luster, but now they appear to be back in vogue.
“If you look on the daily chart below, that’s where buyers have moved in since December, helping to cap yields below this level,” Forex.com added. “But will that remain the case when the momentum with the economy, interest rate expectations and inflation all moving in the same direction? It feels like a matter of when, not if, right now unless something serious in the economy breaks.”
Source: Refinitiv
Take Advantage of Short-Term Yields
While short-term yields are pushing higher, it’s a reminder to fixed income investors that short-term bond funds are an option to park cash temporarily. So, for example, an investor can opt for a short-term bond fund with a more competitive interest rate yield as opposed to a money market fund.
That said, one bond fund to consider is the Vanguard Short-Term Corporate Bond Index Fund ETF Shares (VCSH), which seeks to track the the performance of the Bloomberg U.S. 1-5 Year Corporate Bond Index. The index includes U.S.-dollar-denominated, investment-grade, fixed-rate, taxable securities issued by industrial, utility, and financial companies, with maturities between one and five years. As of February 9, the fund has a 30-day SEC yield of just under 5%.
For fixed income investors who don’t want to take on the additional credit risk of corporate bonds, they can consider the Vanguard Short-Term Treasury ETF (VGSH). The fund tracks the Bloomberg US Treasury (1-3 Y) index, maintaining exposure to high-quality (investment-grade) U.S. Treasury bonds. Despite the focus on safe haven Treasury debt, fixed income investors aren’t sacrificing much yield. The fund’s 30-day SEC yield as of February 8 is 4.42%.
For more news, information, and analysis, visit the Fixed Income Channel.