Negative Duration Bond ETFs To Watch Amid Rising Yields

Growing inflationary expectations and a booming economy have lately led to an uptrend in Treasury yields. Notably, yields on 10-year Treasury notes increased from 2.465% at the start of this year to 2.902% in the earlier session on Monday — the highest level in more than four years. It is currently hovering around 2.829%.

The most recent surge in yields came from solid January job numbers. The government report showed that Americans saw huge gains in pay amid better-than-expected hiring, indicating a solid start to 2018 for the job market. The economy added 200,000 jobs in January, edging past analysts’ expectation of 180,000 while the unemployment rate held steady at 4.1% — its lowest level since December 2000. Meanwhile, average hourly wages rose 0.3%, pushing the year-over-year increase to 2.9%, marking the fastest pace in more than eight years. Robust job numbers sparked a wave of inflation and thereby speculation of aggressive monetary policy tightening.

According to Goldman, yields will continue to rise as high as 3.5% in the next six months as the market prices in a steeper pace of Federal Reserve tightening.

As yields continue to move up, it would hurt the returns of investors, who have big holdings in the fixed income world. If this happens, bond investors might experience heavy losses given that bond prices and yields have an inverse relationship. With the inclusion of some negative duration bond ETFs, this hostile situation can be avoided. Investors could add these products in their portfolio to minimize the risk from rising interest rates.

Why Negative Duration Bond ETFs?

These funds cushion against rising rates through an inverse exposure to Treasuries and increase value when rates rise.

Negative duration bond ETFs offer exposure to traditional bonds while at the same time short Treasury bonds using derivatives such as interest-rate swaps, interest-rate options and Treasury futures. The short position will diminish the funds’ actual long duration, resulting in a negative duration. As a result, these bonds could act as a powerful hedge and a money enhancer in a rising rate environment.

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