ETFs to Make the Most of the Long-Term Yield Surge to 5%

The yield on the 30-year U.S. Treasury bond soared to 5% after the United States lost its last remaining top-tier AAA credit rating, sending ripples through global markets and prompting investors to re-evaluate their strategies.

Moody’s Ratings downgraded the United States’ sovereign credit rating by one notch from Aaa to Aa1, citing escalating deficits and the increasing burden of refinancing debt amid elevated interest rates. The downgrade follows similar moves by Fitch and S&P in recent years and marks a symbolic shift in how the world views U.S. sovereign debt (read: Moody's Downgrades U.S. Rating: What's Next for S&P 500 ETFs?).

While America retains significant influence as the issuer of the world’s reserve currency, the growing fiscal deficit, persistent inflation pressure, and political gridlock have begun to erode that position.

Why Yields Jumped

A downgrade signals increased credit risk, which often causes bondholders to demand higher yields to compensate. While a few believe the United States is at a real risk of default, the loss of top-tier status may push large institutional investors, like pensions and foreign central banks, to rebalance away from long-dated Treasuries.

The move to 5% on the 30-year note also reflects a changing inflation outlook. Sticky core inflation, strong wage growth, and the Federal Reserve’s “higher for longer” stance have fueled the belief that elevated rates may be here to stay.

A rise in yields will benefit a few corners of the market. Investors seeking to capitalize on the opportune moment should consider following ETFs:

Ultra Short-Term Treasury Bond ETFs

Rising yields directly benefit Treasury bond ETFs, particularly those targeting short-duration bonds. Ultra short-duration bond ETFs invest in securities with a duration of less than one year, thus making them less vulnerable to rising long-term rates. As the duration or interest rate sensitivity is lower, these act as a cushion against rising rates (read: Here's How to Invest in ETFs With Warren Buffett's Strategies). 

While there are many options in this space, iShares 0-3 Month Treasury Bond ETF SGOV offers exposure to U.S. Treasury bonds with remaining maturities less than or equal to three months. It follows the ICE 0-3 Month US Treasury Securities Index with an average maturity of 0.10 years and an effective duration of 0.10 years. iShares 0-3 Month Treasury Bond ETF has AUM of $45.7 billion and trades in an average daily volume of 12 million shares. SGOV charges 9 bps in annual fees and has a Zacks ETF Rank #3 (Hold). 

Floating Rate Bond ETFs

Floating-rate bond ETFs are designed to perform well in rising yield scenarios. These funds invest in debt instruments with interest rates that adjust periodically, ensuring that income levels remain competitive as rates rise. iShares Floating Rate Bond ETF FLOT is the most popular option in this space with AUM of $8.8 billion and an average daily volume of 1.5 million shares. 

iShares Floating Rate Bond ETF offers exposure to U.S. floating rate bonds, whose interest payments adjust to reflect changes in interest rates. It follows the Bloomberg US Floating Rate Note < 5 Years Index and holds 412 securities in its basket. It has an average maturity of 1.97 years and an effective duration of 0.01 years. iShares Floating Rate Bond ETF charges 15 bps in annual fees.

Inverse Treasury ETFs

These are designed to rise when bond prices fall (i.e., when yields rise). Inverse ETFs provide opposite exposure to the performance of the underlying index using various investment strategies, such as swaps, futures contracts and other derivative instruments. ProShares Short 20+ Year Treasury ETF TBF provides inverse exposure to the ICE U.S. Treasury 20+ Year Bond Index. It has accumulated $76.1 million in its asset base and charges 95 bps in annual fees. Volume is solid at 121,000 shares a day on average.

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This article originally published on Zacks Investment Research (zacks.com).

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