Fed Rate Hike on the Table, but Don’t Count Treasury ETFs Out Just Yet

on Feb 23, 2017

There has been some economic data, as well as comments made by Federal Reserve Chair Janet Yellen, that suggests the Fed could look to raise interest raise in March 2017. It’s more or less the same story with Yellen, she did not state whether the FOMC would raise interest rates at its next meeting. However, Yellen did have some hawkish comments, which sent U.S. Treasury yields higher, and consequently, U.S. Treasury securities and Treasury bond ETFs fell.

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Yellen’s Hawkish Comments May Indicate Potential Rate Hike

Yellen stated, I can’t tell you exactly which meeting it would be. I would say every meeting would be live…It’s our expectation that rate increases this year would be appropriate.”

With that in mind, the markets could shift their focus back onto the Fed, from President Trump’s potential policy changes. Now, according to the CME Group 30-Day Fed Fund futures prices on February 15, 2017, the markets indicated there was a 26.6% probability, up from 17.7% on February 14, 2017, that the Fed could raise interest rates by 25 basis points.

Fed Chair Yellen also indicated it would be “unwise” to postpone rate hikes. This could be an indication that the Fed may be looking to take precautionary measures, rather than waiting for more economic data to come up to decide whether to raise rates or not.

Rate Hikes Good for Bonds? Some Traders and Experts Think So

Yellen’s comments have some investors and traders shifting their focus back onto the bond market. Trader Jason Bond stated, “The potential rate hikes this year should push U.S. Treasury bond ETFs lower. However, over the long term, high interest rates could actually benefit this type of ETF. Fund managers would be able to reinvest the cash flows received from U.S. Treasury bonds at higher yields. Therefore, rising interest rates could increase income, potentially offsetting the price decline in these ETFs.”

U.S. Treasuries fell again and two-year yields hit its highest level since the beginning of this year. Additionally, five-year yields also hit 2017 highs due to the increased probability of a potential rate hike.

Head of iShares Americas Fixed Income Strategy Matthew Tucker also thinks you shouldn’t count out bond ETFs just yet. Tucker indicated that abandoning investments in bonds when rates rise is one mistake many investors make. Tucker went on to say, “An intermediate fund with a duration of five years may recover price loss from rising interest rates in about five years. And after five years the fund may continue to be investing at higher yield levels, potentially resulting in higher returns. So if you are a long-term investor, you may actually want interest rates to rise.”

U.S. Consumer Price Index

On February 15, 2017, the U.S. Consumer Price Index data was released, and consumer prices showed their biggest gain in close to four years. The U.S. CPI rose by a seasonally-adjusted 0.6% in January 2017, while economists were expecting a 0.3% increase. With this new data, it could push the Fed against the fences and potentially cause FOMC members to vote for a rate hike. The current inflation rate is currently at 1.7%, while the Fed has a 2% inflation target.

The Bottom Line

A Fed rate hike is on the table, and the U.S. Consumer Price Index data could fuel the argument for the need to raise interest rates. Also U.S. Treasury securities could fall in the short term due to an interest rate hike, Treasury bond ETFs could rise since fund managers are able to reinvest at a higher rate. With that in mind, some ETFs to keep an eye on include the iShares Barclays 20+ Year Treasury Bond ETF (NASDAQ: TLT), iShares 3-7 Year Treasury Bond ETF (NYSEARCA: IEI) and the iShares Barclays 7-10 Year Treasury Bond Fund (NYSEARCA: IEF).


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