Sweta Killa: For the U.S. Treasury bonds, especially the long dated ones, 2014 turned out to be a banner year. These bonds enjoyed the strongest annual rally in three years and are continuing their winning streak in 2015. This is especially true, as yields on the 10-year Treasury notes have fallen to the lowest level in 20 months to below 1.9% from 3.03% in the beginning of 2014.
Geopolitical uncertainty, global slowdown and deflation fears are driving demand for safe-haven bonds. Oil prices have been trending down over the past few months and are showing no signs of resurgence. The prolonged decline is troubling the broader economy and has raised risks of a global slowdown and deflation, thereby directing investors toward the ultra-safe U.S. government bonds.
In fact, the Euro zone has already trapped itself in deflation after over five years. Inflation has turned negative in the region with consumer prices falling 0.2% year over year in December. In the U.S., annual inflation rose to just 1.3% in November, the smallest gain since February and still a far cry from the Fed’s 2% target despite solid hiring and falling unemployment. Deflationary pressures and slow wage growth will likely keep the interest rates low or might delay the prospect of an interest rate hike, pushing the yields down and bond prices up.
Coming to global trends, Europe is barely growing, Japan is in recession, Greece might be compelled to depart from the Euro zone, and Russia is facing twin attacks from a low oil price and its tumbling currency. China, Brazil, and other key emerging economies are also witnessing slow growth. As a result, the World Bank cut its 2015 global growth forecast this week, from 3.4% to 3%. All these sluggish fundamentals are boosting the appeal for the long duration bonds.
Moreover, the behavior of yield curve justifies the bullish trend in these bonds. This is because the short end of the yield curve is rising faster than the long end and the spread between the 2-year and 10-year yields tightened to 136 bps at present from 260 bps at 2014 beginning, indicating that the yield curve is flattening. This trend will likely continue since a tight Fed policy is in the cards.
As the U.S. economy is growing at a faster clip not seen in more than a decade, the Fed is on track to raise interest rates sometime in the middle of the year. Some market experts expect the first interest rate hike since 2006 to come faster than expected, resulting in much higher yields since 2009.
According to Bloomberg, 2015 could be disastrous for the U.S. government bonds. The 10-year yields are expected to almost double to 3.4% by the end of 2015, underscoring extremely bearish sentiments since 2009. This would push the long-term Treasury bonds lower, making these the worst investments in 2015.
However, given the flattening yield curve and global uncertainty, investors could definitely look to this corner of the fixed income world and take advantage of the current trends as long as interest rates remain low. Below we have profiled three ETFs that are leading the way higher in the fixed income world over the trailing one-year period and have a favorable Zacks ETF Rank of 3 or ‘Hold’ rating with a High risk outlook.
This ETF follows the BofA Merrill Lynch Long US Treasury Principal STRIPS index and holds 21 securities in its basket. Both the effective maturity and effective duration of the fund is 28.99 years. This fund is often overlooked by investors as depicted by AUM of $111.4 million and average daily volume of 38,000 shares a day.
The product charges 15 bps in annual fees and returned a whopping 55.7% over the trailing one-year period.
Vanguard Extended Duration Treasury ETF (EDV)
This fund provides exposure to the long-term Treasury STRIPS market by tracking the Barclays U.S. Treasury STRIPS 20–30 Year Equal Par Bond Index. The fund holds 70 bonds in total with effective maturity of 25.3 years and average duration of 25 years. Expense ratio came in at 0.12%.
The product has amassed $525.8 million in its asset base while sees moderate volume of 83,000 shares per day on average. It surged over 50% in the trailing one-year period.