Even while the Russian-Ukraine conflict continues to rage on, the fact of the matter is the US, and honestly, the majority of the world is dealing with higher-than-expected inflation. And the most direct way to bring that inflation back down to sustainable levels is for the Federal Reserve and other central banks around the world to take action and increase interest rates.
Prior to the Russian-Ukraine situation occurring, it was widely expected that the Federal Reserve would raise the benchmark interest rate by 0.5% in March. However, now that the war in Ukraine is occurring, many believe the Fed will only increase rates to 0.25% in March and reassess the situation at the following meeting.
However, even while most market participants expect a rate hike of just 0.25%, some Fed officials still believe that a 1.00% rate hike is justified in March. While there is talk of the 1% hike, very few believe it will occur in March, especially since the Russia-Ukraine situation.
Furthermore, market participants also need to consider when and how quickly the Federal Reserve decides to start winding down its balance sheet. Some believe when the Fed begins that process, it could have more of an effect on interest rates than when the Fed actually raises rates since the Fed was a huge buyer of bonds. Since the bond market and bond interest rates are essentially determined by supply and demand, if demand is weak due to limited buyers, the interest rates will increase until buyers step in. With the Fed no longer buying and potentially selling bonds, supply will be high, which will require much more attractive yields in order to entice investors to step in and buy bonds.
So as an investor, how can you profit from this information?
Well, since we know interest rates will likely go higher, we can predict that future bond interest rates will be higher than those currently available to buy today. This means current bond values will fall if interest rates do go higher. The way to make money on this move is by essentially shorting current bond prices.
So first and foremost, you want to make sure you don’t currently own any bonds, especially ones that are going to have a lower yield than what you expect rates to be in the future.
Then you could go the options route and buy puts on bonds or bonds funds, but that is rather complicated and takes a lot of time and energy to monitor the trade. A much simpler solution is buying an ETF that shorts these current bonds. Let’s look at a few of the options you have that allow you to do this.
The first is the ProShares Short 20+ Year Treasury ETF (TBF). This fund gives investors inverse exposure to a market-weighted index that tracks the performance of the US Treasury securities with remaining maturities greater than 20 years. The fund states that TBF is a choice for levered bets on rising interest rates. The fund is not cheap, with an expense ratio of 0.94% and the fund itself resets daily in order to gain leverage; thus, contango decay is a concern if you hold the fund over a long period.
Another option is the ProShares UltraShort 20+ Year Treasury ETF (TBT). This fund is very similar to TBF, but instead of offering investors the standard 1X short exposure, TBT offers 2X short exposure. This fund also has a high expense ratio, at 0.92%, and will certainly have contango decay. Year-to-date TBT is up more than 12%, while TBF is up a little more than 6%.
For those investors who are truly convinced interest rates are going higher, and soon, there is the Direxion Daily 20+ Year Treasury Bear 3X ETF (TMV). This fund does the same as TBF and TBT; it shorts the value of Treasury bonds with a maturity date of 20 years or longer. But it shorts these bonds at a 3X leveraged amount. This is the maximum short exposure you can gain, but it will also have a high rate with high contango decay effects. So, investors should know they should not sit in this fund for an extended period. Year-to-date, the fund is up 26.64%.
Another option is the ProShares UltraShort 7-10 Year Treasury ETF (PST). PST gives investors 2X daily inverse exposure to a market-value-selected and weighted index of US Treasury bonds with remaining maturities between 7 and 10 years. The funds’ performance year-to-date is a positive 6.5%, but it also has an expense ratio of 0.95%, and once again, contango decay will play a role on the fund if you hold it longer than a day.
Above are some of the easier to trade and manage options investors have at their disposal to short bonds and or play a rising interest rate environment. Of course, investors should understand there is no guarantee that any investment will be profitable. All investments that use leverage or are “short” carry more risk than traditional “long” and non-leveraged investment options.
Disclosure: This contributor did not hold a position in any investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.