As investors gear up for another possible hike to interest rates in the US, ETF investors have been surprisingly keen for both shorter and longer-term debt.
The Federal Reserve is expected to raise interest rates this week from 1% to 1.25%. This would be the second rate hike in 2017, following on from an additional hike late last year.
Short and long-dated US debt see inflows
The $6 billion iShares 20+ Year Treasury Bond ETF (TLT) is up more than 6% year to date and flows have followed suit at a cumulative $2 billion over the same period. Normally longer-dated debt, which is more sensitive to interest rate changes, see outflows around interest rate uncertainty.
Shorter-dated debt has also seen inflows. The $1 billion Vanguard Short-Term Government Bond ETF (VGSH), which tracks the Bloomberg Barclays U.S. 1–3 Year Government Float Adjusted Index, has seen almost $500 million inflows despite meagre returns of 0.43%.
More interest rate hikes after June?
The Fed has not given a concrete indication of how many further hikes are to be expected this year, therefore investors’ eyes will be on the Fed’s monetary statement for a better understanding. A Reuters poll found conviction for further hikes after June has dimmed, and the Fed’s preferred measure of inflation has dropped to 1.5% by April, the slowest pace since December 2015.
The hike will, as always, be good for US savers who get more interest on their cash, while it will be tougher news for US consumers and businesses taking out loans which would likely see increased costs.
If the US remains dovish with low interest rates after this year as it unwinds its debt-laden balance sheet of more than $4 trillion, there are several ETF categories that should do well. These include emerging markets, gold and high yield bonds, as lower rates mean a higher appetite for high yield.
As the US slowly raises rates during positive economic data, now almost a decade on from the credit crisis, other markets remain sceptical of the same approach. Canada remains at 0.5% from last year, and Japan, the EU and Australia have mostly kept stable rates from 2016. In the UK, there has only been one change following the vote last June to leave the EU.