Short-Term Bond Yields Rising: Timely ETF Bets

Short-term Treasury bond ETFs appear to have hit the brakes on heightened prospects of a rate hike, after about a decade, in the December Fed meet. A strengthening job market as evident from a new seven-year low unemployment rate in October, an upwardly revised U.S. GDP data for Q3 (from 1.5% to 2.1%) and a decent inflation profile made the Fed confident about pulling the trigger on tightening (read: ETFs & Stocks to Add on Solid Jobs Data).

Rising fears about that the Fed’s benchmark interest rates’ hike lowered the appeal of short-term bond ETFs. As a result, yields are rising faster on the low-and-middle part of the yield curve  than the long end. 
 
Yield on the 6-month Treasury note soared 12 bps from the 0.27% level seen at the start of November to 0.39% on November 25. In the same time frame, the yield on the two-year Treasury note jumped 16 bps while yield on the 10-year Treasury note rose just 3 bps to 2.23% from 2.20%. In fact, in recent sessions, yields on 10-year U.S. treasuries declined.
 
Notably, yield on two-year treasuries presently hover around a five-year high. Yield gap between 2-year and 10-year bonds squeezed to the lowest level seen in nine months, per Wall Street, indicating the flattening of the yield curve.
 
Short-term bond ETFs like iShares 1-3 Year Treasury Bond ETF (SHY), Schwab Short-Term U.S. Treasury ETF (SCHO) and Vanguard Short-Term Government Bond ETF (VGSH) have shed about 0.5% each over the last one month (as of November 25, 2015) (see: all the Government Bond ETFs here).
 
Better Treasury Bets
 
Thanks to the flattening of the yield curve, iPath US Treasury Flattener ETN (FLAT) could be an excellent bet to play the trend.
 
This product provides inverse (or opposite) exposure to the Barclays US Treasury 2Y/10Y Yield Curve Index, which delivers returns from the steepening of the yield curve through a notional rolling investment in U.S. Treasury note futures contracts (read: 3 Treasury Bond ETFs to Play Rising Short Term Yields).
 
The index takes a weighted long position in the 2-year Treasury futures contracts and a weighted short position in 10-year Treasury futures contracts. It generally rises when the yield curve steepens and falls when it is flattening. As such, investors could make smart profits from the flattening of the yield curve through the ETN thanks to its inverse relation with the index.
 
However, investors should note that FLAT is expensive, charging 0.75% in fees and expenses, and has higher trading cost thanks to its illiquid nature. The product is unpopular too as it has amassed just $3.7 million in its asset base. The note gained nearly 1% in the last one month.

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