2023-07-31 15:20:06 ET
Summary
- iShares Treasury Floating Rate Bond ETF is a minimal-duration exchange-traded fund meant to track rates in the U.S.
- It's a Treasury-based instrument that does not have meaningful credit risk, some would say none at all.
- While it also yields well according to the curve of short term rates, it also will respond well to rates staying higher for longer, which is a concern of ours.
- We don't think duration is a no-brainer yet, and like TFLO. Also bond markets think long-term rates are going to be higher. Fair enough to follow the spots over the next year or two.
The iShares Treasury Floating Rate Bond ETF ( TFLO ) is a very short-term bond exchange-traded fund, or ETF, that helps users track spot rates of U.S. treasuries. With long-term rates expected to remain pretty high, and with there still being a lot of uncertainty around immediate future for rates that makes duration a little less desirable at this moment, TFLO seems like a decent position, especially instead of holding cash. While expense ratios are a little on the high side at 0.15%, they're not too high, and TFLO reflects a caution that we think is still advisable in the current market which could react negatively to another disappointment from the Fed.
TFLO Breakdown
The TFLO is a bond ETF tracking treasuries in order to maintain ultra-low duration on average. It accomplishes that and charges a 0.15% fee to do so.
There are a couple of key moving points that contextualize the considerations around a floating rate ETF like TFLO. The first is around economic outlook. The consensus in equity markets is that rates are basically peaked, and that the economy looks good enough at this point where a soft landing is possible. Inflation is around 3%, so the assumption is that inflation will be able to drop to 2% without triggering a recession, since it is quite clear that a recession is unlikely to happen at current interest rates. We do not take this consensus view as our own. The last leg to hit 2% inflation, and the Fed will not budge on that given that they've already made it clear that they'll be happy to trade a recession for assurances of normal rates of inflation, is going to be really tough. Many supply chain pressures and other cost-push elements have been mostly resolved, or are at least up against apples to apple comps in a post-invasion environment.
We think the current inflation is being dictated by demand pull factors that will have to be unwound to allow for a return to lower rates. Economic actors are coming in waves attempting to make their economic levy by raising prices, leading to a persistent inflation. A signal from the demand side is likely to be required in order to stop economic actors from believing that they can carry out more price increases. Probably, a mild recession will be needed and that will have to happen with even higher rates.
The other consideration is around long-term rates. Smart money in the bond market has determined that long-term rates are going to be pretty elevated . Expectations are distinctly higher than a month ago. While 'idiosyncratic' effects from market moving AI-exposed players has helped drive markets, and there has also been follow up with a general laggard rally, further equity market appreciation seems difficult with the upward revision in long term rates that has such an outsized impact on high P/E stocks, which drive the U.S. market. Moreover, these higher expectations also have general deglobalization at least partially baked in.
Bottom Line
The bottom line is that caution is probably a reasonable policy after equity markets have been bought up pretty heavily. Also, duration is risky. A cautious and low duration approach is fully tackled by TFLO, which can be on investors' sliders of their bond to stock allocations. While the 0.15% expense ratio is a little higher than other bond ETFs, the low duration is more expensive to maintain. iShares Treasury Floating Rate Bond ETF is a sensible exposure to reduce risk in the current market.
For further details see:
TFLO: We're Arriving At Peaks, But Smart Money Thinks High LT Rates