A Great Bond ETF To Play Rising Rates

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September 17, 2013 5:09pm NYSE:BSV NYSE:STPP

percent rateThe fixed income world has experienced a huge broad sell-off in the past few months as interest rates continue to rise amid higher chances of the Fed curbing its stimulus soon.


Rates on the 10 Year Treasury bond have soared in the past couple of months, rising from a low around the 1.6% mark, to nearly 3% at present.

Investors are also concerned about a continuation of this trend in the future on the back of improving global economic conditions. The recent robust manufacturing data out of the US, Europe and China supports this situation, leading to huge outflows in the bond market, especially the longer dated ones.

According to Trim Tabs Investment Research, total bond funds shed $36.5 billion in the month ending Aug 22 compared to total outflows of $14.8 billion in July and record $69.1 billion in June. This outflow in the past three months has broken a streak of 21 consecutive monthly inflows (read: Bond ETFs Experience Massive Outflows).

Buoyed by massive bonds outflows, the yield curve (the spread between the yields on short term and long-term bonds) is steepening strongly. This means that the price of long-term Treasuries is falling faster than the short-term ones. Further since the Fed has made it clear that they will keep the short-term interest rates near zero levels for a long time, while they will begin reducing the purchases of longer-term bonds soon, this steepening trend is expected to continue going forward.

In such a backdrop, investors should focus on the strategy that provides exposure to the yield curve in order to make profits from this market trend. This can be done through the only one option in the broad bond ETF space – iPath US Treasury Steepener ETN (STPP).

STPP in Focus

This product directly capitalizes on rising interest rates and performs better when the yield curve is steepening. The ETN looks to follow 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: A Steeper Yield Curve Makes These ETFs Winners).

The fund takes a weighted long position in 2-year Treasury futures contracts and a weighted short position in 10-year Treasury futures contracts. STPP charges 0.75% in fees and expenses while volume is light. This suggests an additional cost for the fund in the form of wide bid/ask spread.

The note gained over 13% over the past three months and is up 16.8% in the year-to-date period. It shows that the product has clearly outpaced the broad U.S. market fund (SPY) as well as the ultra-popular short-term bond (BSV) and long-term bond ETFs (TLT) by wide margins.

From a technical look, STPP is expected to get further boost going forward. The note currently made its new high of $42.38 and its short-term moving averages have managed to stay above long-term levels. The 9-Day EMA is now comfortably above the longer-term 200-Day EMA, suggesting continued bullishness for this ETN.

Meanwhile, the fund’s RSI is at just below 60, suggesting that the fund isn’t too overbought, and that it still has some more room to run. This is further confirmed by an upswing in the Parabolic SAR, although this figure should definitely be monitored closely.

Bottom Line

Given an improving U.S. economy with solid job data and recovering housing fundamentals, it seems that QE3 tapering is on the horizon (read: QE Tapering Could Make These Bond ETFs Winners).

Given this, Steepener ETN could be the best bet in the fixed income world at present, as we could see further gains in this product if the Fed starts tapering and interest rates rise in the future leading to upward movement in the yield curve.

This article is brought to you courtesy of Eric Dutram.


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