Key insights
- Rising 10-year Treasury yields and persistent inflation pressures suggest the Federal Reserve may delay interest rate cuts, impacting bond ETFs. While this scenario is frustrating for investors seeking price appreciation from falling yields, higher current yields offer some protection against further rate hikes and allow for income compounding. The article discusses bond ETFs like AGG and BND, highlighting their Treasury-heavy nature and interest rate risk, and also mentions VGIT as a pure play on intermediate-term U.S. government debt.
With 10-year Treasury yields up 26 basis points since the start of the year and inflationary pressures reignited due to the war in Iran, the Federal Reserve may not be able to lower interest rates this year. Fed funds futures imply as much.
Those instruments indicate that it's all but a sure thing the central bank will stand pat at the upcoming June and July meetings. That's frustrating to investors holding broad bond exchange-traded funds (ETFs) such as the iShares Core U.S. Aggregate Bond ETF (AGG 0.21%) because when yields fall, bond prices rise. Not enough of that is happening this year.
Still, there are surprisingly compelling reasons to consider the iShares exchange-traded fund (ETF) as well as rivals such as the Vanguard Total Bond Market ETF (BND 0.19%).
The iShares ETF tracks the Bloomberg U.S. Aggregate Bond Index, also known as the "Agg." It's a Treasury-heavy index, meaning credit risk isn't an issue, but interest rate risk is. Said another way, declining interest rates often spark price appreciation in broad-based fixed-income funds.
Good news: Higher starting yields can work in investors' favor by helping protect against additional rate increases while potentially setting market participants up for price appreciation when yields decline. Plus, by embracing the relatively low risk 4.5% 30-day SEC yield offered by the iShares ETF today, investors can let their income compound at a higher rate until yields finally decline.
For investors who want a pure play on Uncle Sam-issued debt, the Vanguard Intermediate-Term Treasury Bond ETF (VGIT 0.19%) is one of the funds to consider. This Treasury bond ETF has essentially no credit risk because it only holds U.S. government bonds, but the real perk with this fund is its status as an intermediate-term bond ETF.
This ETF's 103 holdings have an average duration of 4.9 years, putting the fund in intermediate-term territory, as its name implies. That's a potentially valuable trait for fixed-income investors because medium-term bonds are often less volatile than their shorter-duration and longer-dated counterparts. Another benefit is that high-grade intermediate-term bonds are often less correlated with equities than short-term and long-duration bonds, meaning this Vanguard ETF can enhance a portfolio's diversification.
For investors who simply want to reduce rate risk in a big way while still garnering solid income, a variety of short-term bond ETFs merit consideration, including the JPMorgan Short Duration Core Plus ETF (JSCP 0.03%).
This $1.5 billion actively managed ETF carries a 30-day SEC yield of 4.5%, which is impressive given its duration of just 2.8 years and the fact that 80.6% of its holdings are rated AAA, AA, or A.
This ETF may be an attractive alternative for investors looking to move out of money markets or cash, as cash yields are falling and active short-duration ETFs have generated superior returns relative to cash over the past three years.