Fed Hikes Interest Rates to 22 Year Highs: ETF Types to Watch

T-bill ETFs: A Haven in a High-Rate Environment

Treasury bill ETFs, also known as T-bill ETFs, are an appealing asset class in the current climate of rising interest rates. These ETFs hold a portfolio of short-term U.S. Treasury bills, which are government debt securities that mature in a year or less. 

The nature of T-bill ETFs lends itself to a unique structure and function. They consist primarily of U.S. Treasury bills with varying maturity periods, commonly from less than a month to three months. An additional advantage is that they provide monthly distributions, offering a consistent income stream for investors who hold these ETFs.

Another noteworthy feature of T-bill ETFs is their low duration risk. Duration is a measure of a bond's sensitivity to changes in interest rates, and because T-bills have short maturities, their ETFs naturally possess a low duration risk. This characteristic ensures that their prices are less likely to be impacted by fluctuations in interest rates, making them a resilient choice in a rising rate environment.

In terms of default risk, T-bill ETFs represent a very low-risk option. Since these ETFs invest in U.S. Treasury bills, the risk that the issuer might fail to make principal or interest payments is virtually non-existent. That is, securities held by these ETFs are backed by the full faith and credit of the U.S. government, a historically reliable borrower.

The current landscape of high interest rates can be a challenge for many fixed-income investments, but T-bill ETFs can turn this scenario into a benefit. When interest rates rise, newly issued T-bills tend to carry higher yields, which often translates to attractive returns for investors. This creates an opportunity for investors to achieve yields of 5% or more with very low risk.

Here are some of the current T-bill ETFs available to investors in 2023:

1. Global X 1-3 Month T-Bill ETF (CLIP)
2. SPDR Bloomberg 1-3 Month T-Bill ETF (BIL)
3. Invesco Treasury Collateral ETF (CLTL)
4. US Treasury 3 Month Bill ETF (TBIL)
5. iShares 0-3 Month Treasury Bond ETF (SGOV)

STRIPS: A Tactical Play for Risk-Seeking Investors in an Inverted Yield Curve Landscape

For risk-seeking investors betting that we are at or near terminal rates and anticipating an upcoming rate cut that may not be fully priced in, ETFs holding Separate Trading of Registered Interest and Principal of Securities (STRIPS) may be an appealing choice for a high-risk, potentially high-reward bet. 

STRIPS are fixed-income securities sold at a discount to face value and paying no interest until maturity, at which point they pay their full-face value. They are essentially zero-coupon bonds derived from U.S. Treasury bonds after the coupon payments are stripped (pun intended) and sold separately. 

ETFs holding STRIPS can have a very high duration, a result of the long time until the STRIPS' maturity and the absence of periodic interest payments. The lack of coupon payments means that the entire value of STRIPS relies on the final payout at maturity, making them highly sensitive to rate changes.

The current inverted yield curve, where short-term interest rates are higher than long-term ones, adds another layer of intrigue to investing in STRIPS. Such an inversion often signals concerns about a possible recession, as investors flock to long-term bonds, driving down their yields. In this scenario, the Federal Reserve may indeed cut rates to stimulate the economy should a recession manifest. 

Therefore, in the event of a rate cut (such as during a recession), STRIPS and the ETFs holding them would likely benefit more than other fixed-income securities. A decrease in interest rates would raise the present value of the final payment at maturity, driving up the price of the STRIPS. The high duration of these investments amplifies this effect, potentially resulting in significant price gains.

Here are some of the current STRIPS ETFs available to investors in 2023:

• Vanguard Extended Duration Treasury ETF (EDV)
• PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (ZROZ)
• iShares 25+ Year Treasury STRIPS Bond ETF (GOVZ)

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.