After being accommodating in recent years, the Federal Reserve has hinted at the prospect of a rate hike in two years. At the last FOMC meeting, he kept interest rates close to zero, but surprisingly increased the odds of two rate hikes by the end of 2023, earlier than expected in 2024, against the backdrop of faster economic growth and inflation.
The central bank expects inflation to soar this year to 3.4%, well above the 2% target, before falling to 2.1% in 2022. It has also increased GDP growth of 6.5% to 7% for this year, the fastest growing calendar year since 1984. The unemployment rate has remained unchanged at 4.5% as the labor market continues to recover from the depths pandemic and has yet to recover 7 million jobs.
Economic activity and employment have strengthened as rapid vaccination reduced the spread of COVID-19 in the United States. Inflation rose and consumer confidence picked up along with spending. In anticipation of this, interest rates have already risen sharply in recent months. Now, the Fed’s hawkish outlook has led to a further rise in yields. 10-year US Treasury yields saw their biggest increase since early March while 2-year yields jumped to their highest level in a year after the Fed commented.
That said, investors looking to prepare for higher rates might flock to bonds whose yields follow broader interest rates – floating rate bonds.
Why variable rate bonds?
Floating rate bonds are investment grade and do not pay a fixed rate to investors but have variable coupon rates which are often linked to an underlying index (such as LIBOR) plus a variable spread depending on risk. issuers’ credit.
Since the coupons of these bonds are adjusted periodically, they are less sensitive to a rise in rates compared to traditional bonds. Unlike fixed coupon bonds, these do not lose value when rates rise, making them ideal bonds for protecting investors against capital erosion in a rising rate environment.
Investors currently have four floating rate bond ETFs on the market, each of which could be a compelling choice (see: all quality corporate bond ETFs here).
iShares Floating Rate Bond ETF FLOT
This ETF tracks the Bloomberg Barclays US Floating Rate Note
SPDR Barclays Investment Grade Floating Rate ETF FLRN
This ETF tracks the Barclays US Dollar Floating Rate Note
FLTR Investment Grade Floating Rate ETF Market Vectors
This fund follows the Market Vectors Investment Grade Floating Rate Bond. Holding 240 securities, it has an average maturity of 22.72 years and a modified duration of 0.11 years. The product has accumulated $ 608.4 million in its asset base and trades an average daily volume of 213,000 shares. The expense ratio stood at 0.14%.
Invesco VRIG Investment Grade Floating Rate ETF
Investors looking for an active approach might find VRIG an attractive choice. The fund seeks to invest at least 80% of its net assets in a portfolio of quality floating rate instruments denominated in US dollars and issued in the United States. It focuses on US floating rate treasury bills, government sponsored agency mortgage backed securities, US agency debt, structured securities and investment grade floating rate companies, holding 196 bonds in his basket. The ETF has amassed $ 480.7 million in its asset base and trades an average daily volume of 132,000 shares. It charges 30 basis points as an annual fee.
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