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Exchange-traded funds that buy U.S. government and corporate bonds took a hit in February, as Treasury yields rose amid fears over stubbornly high inflation.
While “bonds are back,” 2023 may be “bumpy,” according to a Feb. 28 note from Lawrence Gillum, fixed income strategist for LPL Financial. “We don’t think we’ll see another year like 2022 anytime soon, but despite the higher starting yield levels, we could see periods of negative returns.”
The Vanguard Total Bond Market ETF
BND,
lost 2.7% last month on a total return basis, according to FactSet data. Meanwhile, the iShares 20+ Treasury Bond ETF
TLT,
sank 4.9% in February and the iShares iBoxx $ Investment Grade Corporate Bond ETF
LQD,
dropped 4.2%.
The bond-market losses followed data showing that U.S. inflation in January was hotter than expected, sparking a rise in yields as investors began pricing in expectations for the Federal Reserve to potentially more aggressively raise interest rates to battle the still high cost of living.
When bond yields rise, prices of the debt fall. Bond performance was terrible in 2022 as the Fed rapidly raised its benchmark rate, which currently sits within a target range of 4.5% to 4.75%.
Shorter-duration Treasury bonds fared better than longer-term U.S. government debt in February as investors adjusted their rate expectations. For example, the SPDR Bloomberg 1-3 Month T-Bill ETF
BIL,
eked out a total return of more than 0.3% last month, FactSet data show.
Michael Arone, chief investment strategist for SPDR ETFs at State Street Global Advisors, told MarketWatch in early February he preferred short-term debt. With the Fed signaling continued rate increases to bring down still high inflation in a slowing economy, caution is merited, Arone said in a Feb. 7 interview with MarketWatch, on the sidelines of the Exchange event in Miami.
See: ‘The short end of the curve is very sexy today’: But where should ETF investors bet on bonds?
“We’re cautious” about taking on duration and credit risk, Arone said at the time. Why take such risks when “I can get paid to wait” in the safety of short-duration, U.S. government debt, he said.
Higher yields in the bond market have been attracting investors after rates surged last year. Two-year Treasury yields, for example, ended February at 4.795%, up from 0.730% at the end of 2021, according to Dow Jones Market Data.
The yield on the two-year Treasury note
TMUBMUSD02Y,
was up three basis points at around 4.83% Wednesday morning, FactSet data show, at last check.
“Bonds trade daily and interest rates change throughout the day as well, so that means the market value of a bond will change daily as well,” Gillum said in his note.
“But if you buy and hold a fixed income investment, the short-term volatility you experience due to changing interest rate expectations is just volatility,” he said. “It has very little bearing on the actual total return if held to maturity (or if held to the average maturity of a portfolio of bonds).”
The iShares 1-3 Year Treasury Bond ETF
SHY,
lost 0.8% in February on a total return basis, widely outperforming the iShares 20+ Treasury Bond ETF, FactSet data show.
Read: Bonds seeing worst February in at least 3 decades as inflation worries bite a bit like 2022
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