With the rise in interest rates and yields falling on U.S. government debt, the trend might portend to fixed-income investors, domestic and foreign, to continue gravitating towards high-yield investments and spurning safe-haven assets like government debt.
However, per MarketWatch, “data suggest the makeup of the U.S. bond market is undergoing a sea change. Foreign investors have become less prominent in the Treasury Department’s bond sales, while domestic investors have ramped up their holdings.”
The supply of short-term government debt has pushed up yields, which in turn, has flattened the yield curve–the spread between long-term and short-term yields. Often used as an indicator to predict a recession, the flattening curve suggests that fixed-income investors are not confident regarding the future prospects of economic growth.
“We normally observe the opposite – supply going up as central banks are cutting rates – which makes increased supply much easier to absorb since investors can hope for capital gains and are protected by carry and roll-down from steep curves,” said Ralf Preusser, head of global rates strategy at Bank of America Merrill Lynch.
Related: An ETF That Taps Into Closed-End Funds for High Yields
Risk-On Fixed-Income ETF
On the opposite spectrum, investors loading up on safe-haven government debt can still capitalize on high-yield ETFs to take advantage of short-term interest rate hikes that are to be expected as the Federal Reserve hints at further tightening with respect to monetary policy. One such ETF is the ProShares High Yield—Interest Rate Hdgd (BATS: HYHG).
HYHG tracks the performance of the Citi High Yield (Treasury Rate-Hedged) Index and allocates 80% of its total assets in high-yield bonds and short positions in Treasury Securities in order hedge against rising rates. Because HYHG invests in high-yield bonds, there is credit risk associated with the higher yield since the fund invests in corporate issues that are less than investment-grade. By targeting a duration of zero, HYHG offers less interest rate sensitivity versus its short-term bond peers.
For more trends in fixed income, visit the Fixed Income Channel.