Recommendation: You should favor longer-dated Treasuries

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The 10-year Treasury yield still appears attractive relative to sovereign rates elsewhere in the world. In addition, longer-dated Treasuries also look more attractive than those with two- to five-year durations, which are likely to exhibit the most volatility and be most vulnerable to rising rates.

rate sensitivity

Market Realist – The Fed is likely to increase rates in the next year. An increase in rates will affect not only U.S. equities (SPY) and bonds (BND) but international markets (QWLD) as well.

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The graph above shows how yields of U.S. Treasuries closely follow the federal funds rate. The movements are amplified in the longer-term U.S. Treasuries (IEF)(TLT). As the federal funds rate increases, the yields of short-term maturities too increase while their prices fall. However, the yield surges in longer maturities are likely to be much higher, all else being equal, since their prices fall more than short-term bonds. This suggests that investors will be better off holding bonds that decrease the aggregate maturity or duration of their portfolio.

Having said that, longer-term U.S. Treasuries aren’t likely to be as adversely affected as usual by an increase in rates. As we discussed in the previous part of this series, investors often treat U.S. Treasuries as safe haven assets—much like gold (GLD) and silver (SLV). This means that the subdued growth in Europe, Japan (EWJ), and China (FXI) and the geopolitical turmoil currently prevalent in the economy could keep yields low for a while.

Read on to the next part of this series to learn why you should go for high yield bonds.

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