Fixed Income ETFs: Rise in Treasury yields does not mean bear market for bonds

Apr 1st, 2012 | By | Category: Fixed Income

Rising yields on 10-year US Treasury bonds should not be viewed as a sign of the beginning of a bear market in the bonds, according to fixed income specialists Standish Mellon Asset Management, part of BNY Mellon.

Fixed Income ETFs - Rise in US Treasury yields does not mean bear market for bonds

Standish predicts that 10-year Treasury yields may settle into a new higher trading range between 2.25% and 3.00%.

Instead, Standish predicts that 10-year Treasury yields may settle into a new higher trading range between 2.25% and 3.00% by the end of 2012. Fair value for the bonds is approximately 3.30%, according to Standish’s bond model.

Standish made the observation in its April outlook, written by Thomas Higgins, global macro strategist for Standish. The April outlook was issued after 10-year US rates rose from less than 1.9% at the beginning of the year to 2.4% in late March 2012.

The rise has been driven by a combination of better-than-expected US economic data and a reversal in the flight-to-safety bid as the risk of a European banking crisis has appeared to subside, according to the report.

“While speculation is rising that the long-awaited bear market in bonds has arrived, we believe that such thinking is premature,” Higgins said. “There are a number of factors that could limit how far interest rates can rise in the short term, including the Federal Reserve’s intervention in the Treasury market to keep long-term interest rates low.”

FEATURED PRODUCT

Pimco Short-Term High Yield Corporate
Bond Index Source ETF (STHY)

– Provides active exposure to the short-maturity
segment of the US high-yield corporate bond universe

– Utilises Pimco’s experience and expertise in both
portfolio optimisation and global high-yield investing

– UCITS III compliant, LSE listed, UK Reporting
Status, eligible for ISAs and SIPPs

– TER of just 0.55%, considerably less than
comparable OEICs or Unit Trusts

The outlook cites other factors that may help keep rates low, including deleveraging, demand and geopolitical risks.

Americans continue to deleverage from the housing boom of 2002 to 2007 as households continue to allocate a portion of income to debt repayment.  This could mean below-trend economic growth, modest inflation and lower long-term interest rates.

Demand for Treasuries from banks and other financial institutions has increased as they become more conservative in their lending and investing.

Geopolitical risks and potential policy mistakes could push interest rates back down toward their recent lows.

Commenting on the outlook, Desmond Mac Intyre, chairman and chief executive officer of Standish, said: “US investment grade and high yield corporate bonds continue to offer an attractive yield versus Treasuries in the current low-rate environment. We expect these sectors to perform well given positive economic growth and muted corporate defaults.”

For UK-based investors looking to access US investment grade and high-yield corporate bonds the following two London-listed ETFs are worth a look.

iShares Markit iBoxx $ Corporate Bond ETF (LQDE)

The iShares Markit iBoxx $ Corporate Bond ETF aims to track the performance of the Markit iBoxx $ Liquid Investment Grade Top 30 Index as closely as possible. The ETF invests in physical index securities and offers exposure to the 30 largest and most liquid US dollar-denominated corporate bonds with investment grade rating. Only bonds with a minimum remaining time to maturity of two years and a minimum amount outstanding of $1 billion are included in the index.

Pimco Short-Term High Yield Corporate Bond Index Source ETF (STHY)

The Pimco Short-Term High Yield Corporate Bond Index Source ETF aims to replicate the performance of the BofA Merrill Lynch 0-5 Year US High Yield Constrained Index by investing in a range of securities broadly similar to the constituents of the index. The fund seeks to achieve the yield, volatility level, and low or negative correlations with other asset classes inherent in short maturity high yield. STHY is the first European-listed ETF focussed on the short end (0-5yr) of the high-yield corporate bond sector.

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