Expectations of interest rate reductions by the Fed usually encourage fixed income investors to take on more duration risk. That’s a sensible approach. That’s because longer-dated bonds are more sensitive to rate changes than their short- and ultra-short-term peers.
Current conventional wisdom indicates the central bank could lower borrowing costs this month. Therefore, bond investors may be preparing to jettison short-term exposures. But that could prove, well, short-sighted. In fact, ETFs such as the WisdomTree Yield Enhanced U.S. Short-Term Aggregate Bond Fund (SHAG) still merit consideration.
SHAG, which follows the Bloomberg U.S. Short Aggregate Enhanced Yield Index, doesn’t just mitigate rate risk as highlighted by an effective duration of just 2.55 years. It presents investors with a high-quality avenue for dependable income.
“Short-term bond portfolios invest primarily in corporate and other investment-grade US fixed-income issues and typically have durations of 1.0-3.5 years,” noted Morningstar’s Gabe Alpert. “These portfolios are attractive to fairly conservative investors, because they are less sensitive to interest rates than portfolios with longer durations.”
Sizing Up SHAG Opportunities
Demand is often solid for U.S. government debt — bonds that comprise a significant portion of the SHAG portfolio. But new sources of demand could materialize amid potential regulatory changes. That could be a plus for ETFs like SHAG.
“The Federal Reserve will be meeting with other regulators to discuss softening rules that limit banks’ ownership of Treasuries. The extent to which revenue from proposed and implemented new tariffs may offset costs of new legislation will also impact the supply-and-demand equation,” observed U.S. Bank Wealth Management.
Another reason SHAG is worth monitoring over the near-term is because it’s not a foregone conclusion that the Fed will lower rates later this month. Core inflation rose 2.9% in July, the biggest increase since February.
“Inflation continues to rise, which may complicate things for the Fed down the road. For now though, stocks are at record highs and an in-line PCE report should lend more confidence to a September rate cut,” wrote eToro U.S. investment analyst Bret Kenwell in a recent report.
Path of Least Resistance …?
That picture could be muddled by the August jobs report, due out on September 5. If it’s strong, the Fed could consider that along with a stout July consumer spending report and view the U.S. economy on solid ground. Obviously, that would be good news. But it could diminish the case for a rate cut, particularly with inflation proving sticky. For now, the path of least resistance appears to be more accommodative monetary policy. But it doesn’t hurt to prepare for surprises with SHAG.
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