As Key Fed Interest Rate Decision Approaches: Here Are 5 Bond ETFs To Keep An Eye On

Zinger Key Points
  • Investors are waiting for the Federal Reserve's policy announcement, which might signal the end of the rate-hike cycle.
  • If the Fed indicates that rate increases will continue, the bond market will likely react negatively.

Both the stock market and the bond market will be significantly affected by the upcoming Federal Reserve's interest rate decision. 

The market is now nearly fully pricing in a 25-basis-point raise to 5%-5.25%, according to the CME Group Fedwatch tool, but what the Fed hints to do beyond May is what keeps investors on alert. 

The market's attention will mostly be directed at determining if this is the Federal Reserve's last rate hike in the current cycle, or whether Fed Chair Jerome Powell will leave the door open for an additional increase in June. 
The second hypothesis would cause heavy market fluctuations, since this scenario is not discounted by investors, who expect the Fed to conclude its rate increases in May. 

How U.S. Treasuries Could React To The Fed's Meeting

The yield on the two-year Treasury note is currently at 4%, while that on the 10-year benchmark is at 3.46% as the May FOMC meeting approaches.

If the Fed suggests that rate hikes have ended and adopts a rather gloomy perspective on the economy and the labor market, U.S. Treasury yields are projected to fall further, driving up the price of U.S. government bonds.

A hawkish Fed, with Chair Powell rejecting current market expectations of a pause in June and the start of rate cuts later this year, would likely be detrimental to the Treasury market, as rates would rise to reflect the Fed's higher-for-longer attitude on interest rates.

5 Bond ETFs to Keep an Eye On Ahead of the May FOMC Meeting

• iShares 1-3 Year Treasury Bond ETF SHY

The iShares 1-3 Year Treasury Bond ETF is an exchange-traded fund managed by BlackRock, Inc. BLK that invests in U.S. Treasury securities with maturities higher than or equal to one year but less than three years.

As a result, SHY is sensitive to short-term Fed interest rate speculation, although its volatility is normally limited due to its short duration.

When an unexpected negative shock strikes the market and leads the Fed to become more dovish, it is one of the assets that tend to increase because investors regard it as a safe haven.

SHY has risen 1% thus far in 2023 and has recorded outflows of $352 million over the last month.

• iShares 20+ Year Treasury Bond ETF TLT

The iShares 20+ Year Treasury Bond ETF is an exchange-traded fund managed by BlackRock that invests in U.S. Treasury securities with maturities higher than 20 years.

As a result of its high duration, TLT is very sensitive to medium-term Fed interest rate expectations and often shows heightened volatility to interest-rate shifts.

When recessionary shocks hit the economy and induce a decrease in inflation expectations, this asset appreciates significantly.

TLT has risen 4.1% year to date and has attracted inflows of $1.8 billion over the last month. 

Read next: How to Buy Treasury Bonds

• iShares iBoxx $ Investment Grade Corporate ETF LQD

The iShares iBoxx $ Investment Grade Corporate Bond ETF is an exchange-traded fund managed by BlackRock that invests in investment-grade corporate bonds with at least three years to maturity.

Investors sometimes flee to the fixed rates of safer corporate bonds during moments of risk-off in the stock markets

LQD has risen 2.7% year to date and has attracted outflows of $720 million over the last month. 

• iShares iBoxx $ High Yield Corporate Bond ETF HYG

The iShares iBoxx $ High Yield Corporate Bond ETF is an exchange-traded fund managed by BlackRock that invests in high-yield corporate bonds with maturities of at least one year and less than 15 years.

Due to its exposure to junk corporate bonds, HYG is a more volatile investment that tends to follow the sentiment on global stock markets.

Periods of abundant liquidity and limited corporate defaults are a perfect environment for HYG to grow, yet when interest rates rise and there is anxiety about widespread defaults in the corporate sector, HYG declines.

HYG is up 1.1% year to date and attracted inflows of $2.07 billion over the last month.

• iShares J.P. Morgan USD Emerging Market EMB

The iShares J.P. Morgan USD Emerging Markets Bond ETF is an exchange-traded fund managed by BlackRock International Limited and BlackRock Fund Advisors that invests in USD-denominated bonds of emerging countries across the globe and seeks to replicate the performance of J.P. Morgan EMBI Global Core Index.

EMB is also a highly volatile bond ETF that is also tightly correlated to HYG given its "risk-on" profile. Therefore, lower Fed interest rates and prospects of abundant liquidity in markets are what send EMB higher. On the other hand, higher U.S. Interest rates and rising Treasury yields represent major headwinds.

EMB has gained 0.4% year to date and has registered outflows of $215 million over the last month.

Now Read: Investors Reduce 2023 Rate Cut Bets Ahead Of FOMC: Analysts Now Expect Fed On Hawkish-Hold Mode For Longer

Some elements of this story were previously reported by Benzinga and it has been updated.

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Posted In: BondsSpecialty ETFsEmerging Market ETFsTop StoriesEconomicsFederal ReserveMarketsETFsICYMIInflationInterest Rates
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