Treasury Bond ETFs Test Long-Term Support

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June 13, 2013 12:50pm NYSE:IEF

Municipal BondDavid Fabian: The volatility in bonds over the last month has been a wakeup call to many investors who have been complacent with their fixed-income portfolios. The catalyst for this volatility was recent comments from the Federal Reserve

about tapering their asset purchase program which sent the 10-Year Treasury Yield Index to its highest level of the year at over 2.1%.

Consequently, bond prices (which move inversely to bond yields) have suffered some of their worst monthly losses in recent memory. In fact, you would have to go all the way back to November of 2010 when the Federal Reserve launched QE2 to see this big of a drop in Treasury bond prices over such a short period of time.

One of the most well-known exchange-traded funds that is susceptible to the machinations of intermediate-term interest rates is the iShares 7-10 Year Treasury Bond ETF (NYSEARCA:IEF). This ETF commands $4.5 billion invested in 22 U.S. Treasury bonds with a weighted average maturity of 8.29 years. The current 30-day SEC yield on IEF is 1.48% and its expense ratio is just 0.15%. So far this month IEF has fallen 2.84% through May 29.

If you look at the chart above of IEF you can see that there is a great deal of support right at $105 which is close to where we sit right now. If it pierces this level, it could be the sign of a new breakdown in treasury bonds that will lead fixed-income prices even lower. Higher yields and lower bond prices will ultimately lead to higher mortgage rates, auto loans and other credit facilities which will directly affect the economic recovery efforts.

One obstacle that is stacked against the case for higher interest rates is the lofty levels that the stock market has attained this year. If we start to see a breakdown in stock prices, more than likely that will start a flight to quality in Treasuries that will push interest rates lower. Investors still view bonds as a safer bet than stocks during periods of volatility which makes funds like IEF even more attractive at these levels.

I don’t believe that the Federal Reserve is going to taper its bond purchases early or begin a significant shift in its zero interest rate policy until we see a stronger recovery in the job market. That being said, it’s important to look at the overall duration of your fixed-income portfolio to determine if you have significant exposure to interest rate risk. At some point in the future we are going to see an important shift in the risk dynamic of Treasury bonds which will lead to heavy selling in this sector. You will need to be nimble with your income portfolio in order to sidestep that decline which is why you should be evaluating strategies for risk management.

If you have already experienced the brunt of this interest rate rise, I would recommend that you continue to hold quality fixed-income for the time being in anticipation of a bond rally. Investors that have heavy stock exposure might even look to making some opportunistic purchases at these levels to hedge their portfolios. With the right game plan in place you can weather this interest rate storm and come out on top a winner.

This article is brought to you courtesy of David Fabian from Fabian Capital Management.

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