Financial Advisors: Don’t Sleep on the Treasury Market

If rates go higher, these ETFs are game-changers.

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Reviewed by: Lisa Barr
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Edited by: Ron Day

The stock market gets the bulk of investors’ attention. However, recent news from the bond market may prompt advisors to take notice in ways they’ve not had to over the past 15 years or so.  

Specifically, the 10-year US Treasury Bond yield, which vaulted by a whole decimal place from 0.40% to 4.00% from March 2020 through this summer, is showing signs of continuing higher.  

Last year showed us that bonds can be volatile, just like stocks. And while many investors may dismiss a sharp rise in rates as a one-time thing, what if it isn't temporary? What if inflation and long-term interest rates go much higher, as they have done in past cycles?  

Schwab's Jeffrey Kleintop posted a chart to Twitter over the weekend, showing that the current market climate is tracing out a pattern similar to past high-inflation cycles. So, advisors and investors must account for the possibility that inflation may not be fading, but simply resting. 

The case for still-higher long-term rates was potentially bolstered by Friday's PPI report, which showed that price pressures still exist in the earlier part of the "supply chain," where goods are produced so we can consume them later.  

Treasury Trouble 

Then, there was the news last week that the Treasury is having trouble getting sufficient demand for its new bond issues at auction. Translation: the need to pay higher yields and issue more bonds going forward.  

The bond market technical picture isn’t providing much comfort either, as the 10-year U.S. Treasury bond yield threatens to break above last October’s high of 4.3%.  

Should such a move occur and be more than “transitory” (borrowing that word from Fed Chair Jay Powell), past targets of 5.3% and even 6.7% could get investors’ attention. Those are peaks from back in 2007 and 2000, which are also the last two times the stock market peaked. 

For those wanting to attack a continued bond bear scenario, but looking for the right tools for the job, ETFs provide some intriguing considerations. 

A pair of ETFs allow investors to essentially short parts of the U.S. Treasury bond market. The ProShares Short 20+ Year Treasury ETF (TBF) and the much smaller ProShares Short 7-10 Year Treasury ETF (TBX) aim to perform opposite of those parts of the Treasury yield curve. 2022 showed the potential of this approach. TBF was a rare winner amid weak stock and bond markets, gaining 54% year –to date through Oct. 24 of last year before sliding back.  

Note that these are not buy-and-hold types of ETFs. To that end, TBF saw its assets rise above $800 million during 2022, but it sits at just $186 million now. TBX is less liquid, but since it targets a shorter section of the yield curve, it also tends to be less volatile than TBF. 

Another way to play offense against a resumption of higher bond rates is to consider ETFs that own floating rate bonds. If rates head higher, owning bonds whose rates adjust higher in sync with that is a straightforward concept, yet many investors may not realize is easily transacted through an ETF vehicle. Advisors can do the research and carry that key message. 

The iShares Floating Rate Bond ETF (FLOT) or the iShares Treasury Floating Rate Bond ETF (TFLO) are each very liquid (with over $7 billion and $9 billion in assets, respectively, and daily average trading volume of $53 million and $167 million, respectively). FLOT’s duration is a bit longer and its average credit rating is A, as it mostly owns non-Treasury ETFs.  

Rising rates continue to be a threat. But financial advisors who get in sync with the realities of today’s new higher-inflation, higher interest rate era, however long it lasts, have a true practice differentiator in ETFs built for times like these. 

Rob Isbitts was an investment advisor for 27 years before selling his practice to focus on ETF research and education. He is based in Weston, Florida. Contact him at  [email protected] and follow him on LinkedIn.