Rates Rising...Who You Gonna Call?

With Halloween less than a week away, investors are wondering if the bond market will be giving out tricks or treats. If recent trading activity is any guide, it looks like things are getting rather “spooky,” as U.S. Treasury (UST) yields are rising all across the coupon curve, bringing absolute levels back to pre-pandemic levels in some cases. So, in order to obtain some potential future rate protection (and in honor of the time of year we’re in), I have to ask the question: who you gonna call?

Based upon recent inflows, it looks like one rate-hedge solution that got the call was the WisdomTree Floating Rate Treasury Fund (USFR). Indeed, just last week USFR saw more than $600 million of inflows. Interestingly, this buying activity was juxtaposed against most other UST-based securities witnessing visible selling pressure, including TIPS and short-duration fixed coupon Treasuries. 

Let’s take a look at the rate backdrop for a minute. In my blog post from last week, “Five and Dime,” I discussed how other parts of the Treasury market, namely the 2-year and 5-year sectors, had joined the 10-year maturity into higher yield territory. That trend was certainly built upon last week, highlighted by a 2-year yield at roughly 0.50%, a 5-year at 1.20% and the 10-year hitting the 1.70% threshold.

What’s at the root cause, you might ask? It has become increasingly apparent the collective market is becoming more concerned about inflation. Indeed, the five-year breakeven spread (a widely watched measure of inflation expectations) rose to just under +300 basis points (bps), its highest reading since 2005. In addition, the outlook for future Federal Reserve (Fed) policy has also become less friendly for Treasuries. Sure, a tapering announcement at next week’s FOMC meeting has been built in for awhile now, but as we’ve discussed on many occasions, the market’s attention has quickly turned to the next phase of the policy maker’s exit strategy, rate hikes. As of this writing, Fed Funds Futures have now essentially “priced in” two Fed rate increases for next year. Remember earlier this year when “taper talk” was just “talk” and virtually no one was thinking about rate hikes? My, have things changed!

Conclusion

Given the recent trading activity in the Treasury space, one could argue that investors appear to be starting the process of preparing their bond portfolios for further increases in rates. The intriguing aspect to all of this is that the Fed hasn’t even moved toward “liftoff” quite yet. The natural question becomes what happens when the Fed actually does begin to raise rates? My suggestion: don’t wait that long.

Important Risks Related to this Article

There are risks associated with investing, including possible loss of principal. Securities with floating rates can be less sensitive to interest rate changes than securities with fixed interest rates, but may decline in value. The issuance of floating rate notes by the U.S. Treasury is new, and the amount of supply will be limited. Fixed income securities will normally decline in value as interest rates rise. The value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments. Due to the investment strategy of this Fund, it may make higher capital gain distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.

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Source: wisdomtree.com

Rates Rising...Who You Gonna Call?