A New Era For Bond Funds

Momentum has shifted to favor the bears.

Thanks to some surprisingly good job numbers and Fed jawboning, the market — or, more properly, the markets — are now repricing for rising interest rates. The odds of a snug-up at the short end of the yield curve rate has jumped from 6 percent last month to 70 percent now, at least according to Fed Funds futures pricing.

Fixed income securities and ETFs reacted negatively to comments made by Fed chair Janet Yellen and even more so to the beat in non-farm payrolls. Look at the variable effect last week’s job number had on the iShares family of U.S. government bond and note ETFs:

iShares ETF (Maturities) Duration Loss (5 Nov- 11 Nov)
SHY (1-3 Years) 1.8 -0.05%
IEI (3-7 Years) 4.5 -0.31%
IEF (7-10 Years) 7.6 -0.71%
(TLH (10-20 Years) 9.6 -0.83%
TLT (20+ Years) 17.5 -1.53%

You can see two forces working in the table. First, the bond market is discounting a December rate hike. The Fed Funds rate, remember, hasn’t changed yet. Traders and investors are merely pricing their bonds and notes in anticipation of Fed action.

Second, duration risk is reflected in the ETFs’ disparate losses. Duration measures the sensitivity of a fixed income investment a change in interest rates. The bigger the duration number, the greater the investment’s response to rate shifts. Longer-dated paper, all else equal, gives you more duration — a good thing when rates are falling; not so much when the Fed tightens.

The bond market didn’t wait for last week’s job number to roll over. There were wobbles in market momentum for the iShares 20+ Year Treasury Bond ETF (NYSE Arca: TLT) going back to July but it wasn’t until October 29 that a collapse was signaled by the Moving Average Convergence Divergence (MACD) indicator.

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DisclosureBrad Zigler pens Wealthmanagement.com's Alternative Insights newsletter. Formerly, he headed up marketing and research for the Pacific Exchange's (now NYSE Arca) ...

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