Sector selection and yield curve positioning decisions are difficult in rising rate environments, but in this week’s Bond Market Perspectives, we took a look at how shorter-maturity fixed income may be a good place for suitable investors to play defense as it offers an attractive risk/reward profile.
Short-term bonds tend to be less interest rate sensitive, but also offer lower potential yields, than their longer-term counterparts, which makes sense given that they don’t require investors to tie up their money for as long. This, coupled with the fact that short-term rates have moved markedly higher in recent months as markets have priced in a faster pace of Federal Reserve (Fed) rate hikes, means that short-term holdings may offer investors an opportunity to reduce interest rate risk without sacrificing potential yield.
Chief Investment Strategist John Lynch explains, “We continue to expect that rates will move gradually higher across the curve in 2018, and that the 10-year Treasury yield will end the year in a range of 2.75% to 3.25%. For investors concerned about rising rates, the short-end of the yield curve may offer an attractive trade-off between yield and interest rate risk.” The risk-reward trade-offs can be seen by looking at various maturity segments within the Bloomberg Barclays U.S. Aggregate Bonds Index. In this case, looking at the yield of each component, relative to its interest rate sensitivity, shows that shorter maturities currently offer substantially more reward (yield) per unit of interest rate risk (duration) [as seen in the chart below].