A Great Bond ETF To Play Rising Rates

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.

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