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Fed Rates Rise – We Trade This With TFT Or GOVT Bond ETFs?

Trade Treasury ETF Shares Your Capital Is At Risk
Updated 16 Jun 2022

Key points:

  • Either TLT or GOVT ETFs will move in interest rate changes
  • Which way they will move depends upon market expectations
  • So, trading them requires predicting market sentiment

As announced the Federal Reserve is now aggressively raising interest rates in order to beat back inflation. So, how do we trade this? Perhaps using the iShares US Treasury Bond ETF (BATS: GOVT) or the iShares 20 Year (NASDAQ: TLT) ETF. Or perhaps we should be looking entirely the other way and trying to short the market?


The answer is, sadly, more complex than we might wish it were. For, yes, rising interest rates do decrease the price of bonds at any fixed coupon. They thereby increase the yields of those same bonds. So, after an interest rate rise bonds are a more attractive investment than they were before – as long as we're thinking in static terms. So, if we just think about rising interest rates it's easy. But interest rates never do “just rise”, there's always a set of expectations about what the next change is going to be.

Further, those expectations are going to be backed into market prices – because that's what market prices are, expectations made flesh in cash money. So, to take the example of US Treasury prices. today. They already contain that .75 point rise of yesterday. Therefore so do the varied ETF prices like TLT and GOVT. The Fed has also told us – or rather Jerome Powell did, that he expects – a further 50 or 75 point rise at the July meeting. The probability of that is now already in both Treasury and ETF prices.

Also Read: How Does Inflation Affect The Stock Market?

We are back in that old efficient markets hypothesis world. Information already known is already in prices. So, it's new information that will change prices, not the things everyone already knows.

This produces the trading platform that we've got to start with, therefore. If we think that the next rise will be the last major one, and that something like the current 3%, 3.3%. is what we'd like to get on our risk free money, then buy either Treauries or one of the ETFs by all means. But to buy either as a trading position, rather than a holding, we've got to disagree with that commonly held knowledge.

Perhaps we think inflation is going to fade faster – it's possible that it will. There really have been blockages and snafus in the economy, it's not all excessive money printing this inflation. If so then yes, being long GOVT ot TLT makes great sense. As the interest rate rises don't arrive, then they will move higher – don't forget bond yields are inverse to price.

On the other hand, if we think inflation is going to continue, that significant rate rises will continue, then we'd want to be in one of the bear ETFs – short Treasuries, that is (no, not SHV, that's short Treasury maturities, not being short of Treasuries themselves).

The important point here is that, yes, ETFs can be a simple and convenient way of trading such price movements, But they don't handle for us the decision-making on what the movement is going to be. For that we still have to depend on that traditional macroeconomic analysis. Which way is inflation going to go and how is the Fed going to react to it? Sadly, there's no substitute for that.