Though the fixed income world, in particular Treasury bonds, gathered some steam starting this year, these are faltering again thanks to the Fed latest comments. The Fed, which has committed to keep short-term interest rates at a near zero level, signaled a rate hike sooner than expected.
This is especially true as Janet Yellen withdrew the unemployment rate threshold of 6.5% before raising rates. Now, the Fed views increase in short-term rates six months after the current monthly bond purchases program ends, which is expected this fall. As such, short-term interest rates are expected to move up by the middle of 2015.
This concern has led to a broad sell-off in the Treasury bond market, resulting in spiking yields. Unlike last year, short-term Treasury bonds are the worst hit this time while intermediate and long-term Treasury bonds are trending lower.
This is because the short end of the yield curve is rising faster than the long end, and the spread between both the two yields is narrowing. The spread between the 2-year and 30-year yields tightened to the lowest since July, indicating that the yield curve is flattening.
This trend is likely to continue in the coming months, suggesting investors might want to avoid riding the yield curve or take an inverse position. This could be easily done through the only option in the broad bond ETF space – iPath US Treasury Flattener ETN (NYSEARCA:FLAT).
FLAT in Focus
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 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 $4.7 million in its asset base.