6 Bond ETFs To Play Higher Rates

The start of the fourth quarter has renewed worries over the Fed rate hike on a slew of positive economic indicators. Richmond Federal Reserve President, Jeffrey Lacker, early this week cited a strong case for a rate hike in December. Additionally, the probability of a Fed lift-off in December has increased to above 60% as per the federal-funds’ futures market while CME Group's FedWatch Tool shows a 63% chance of an increase in December.

As a result, Treasury yields increased sharply with the 10-year yields now at 1.72% — the highest level in two weeks. This is especially true as manufacturing activity rebounded strongly in September with the ISM index rising to 51.5 from 49.4 in August. Additionally, the U.S. economy supposedly gained momentum in Q2 with GDP growth revised to 1.4%, up from 1.1% from the previous estimate and 0.8% recorded in Q1.

Consumer confidence spiked to the highest level since recession in September, as measured by the Conference Board, while it climbed for the first time in four months as per the Thomson Reuters/University of Michigan index. Fresh worries that ECB will gradually cut its €80 billion bond buying program ahead of the planned conclusion in March 2017 and risk-on trade have also contributed to the increase in yield.

Given the improving fundamentals, an increase in rates seems justified. As rates rise, bond investors might experience heavy losses given that bond prices and yields have an inverse relationship. While this is true, there are still several compelling choices in the fixed income ETF world that could protect investors from rising rates.

Below we highlight six bond ETFs that could be great picks in the rising rate environment.

iShares Floating Rate Bond ETF (FLOT - Free Report)

Floating rate notes are investment grade bonds that do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of issuers. Since the coupons of these bonds are adjusted periodically, they are less sensitive to an increase in rates compared to traditional bonds. As such, unlike fixed coupon bonds, these will not lose value when the rates go up. Hence, it protects investors from capital erosion in a rising rate environment.

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