Market Extra: Investors embrace these Treasury ETFs despite September slump, as ‘belly’ of yield curve outperforms long end

ETFs that buy long-term Treasurys have slumped this month as bond yields surged following the Federal Reserve’s decision earlier this month that signaled interest rates may remain at higher for longer as it seeks to curb elevated inflation. The so-called belly of the Treasury market’s yield curve looks more attractive to BlackRock’s senior iShares investment strategist Kristy Akullian. 

“We see the three-to-seven year part of the curve as the sweet spot,” she said by phone. 

The iShares 3-7 Year Treasury Bond ETF
IEI
on Tuesday saw its biggest inflow since July, attracting $170 million from investors in its third straight day of inflows, FactSet data show. The fund is faring much better than the larger iShares 20+ Year Treasury Bond ETF so far this month, down 1.4% through Tuesday on a total return basis. 

While the short-end of the yield curve has been popular with investors in offering rates above 5%, many investors have been eyeing a move into longer-term Treasurys, according to BlackRock’s Akullian.

“We want to step out of cash and add some duration” in the “belly of the curve,” she said. “It pays to be a little early rather than a little bit late.” 

Read: ETFs that buy long-term Treasury bonds drop sharply after Fed signals higher for longer rates

While the Fed has rapidly raised its policy interest rate since early 2022 in a bid to bring down inflation, many investors anticipate that it is now near the end of its hiking cycle as the surge in cost of living has eased in the past year. Investors have also considered the Fed’s tight monetary policy could lead to an economic slowdown in the U.S., prompting the central bank to potentially begin lowering rates in 2024.

“When the Fed does start to cut interest rates we’ll see a positive price appreciation in longer duration assets,” said Akullian. “In cash, you’re not getting any of the price appreciation, you’re just getting yield.”

Akullian sees room for long-term Treasury yields to move higher. Investors may demand higher yield to “be locked up for longer,” she said, pointing to challenges such as a deterioration of fiscal conditions in the U.S. as well as the Fed’s ongoing quantitative tightening program under which it’s allowing Treasurys it holds on its balance sheet to mature each month. 

Meanwhile, ETFs that hold cash-like Treasury bills have stayed in positive territory this month. 

For example, the iShares 0-3 Month Treasury Bond ETF
SGOV
has seen a total return in September of 0.3% through Tuesday, according to FactSet data. Three-month Treasury bills
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were yielding 5.49% on Wednesday afternoon, compared with near zero in late 2021 before the Fed began aggressively hiking rates last year.

On the longer end of the yield curve, the rate on the 10-year Treasury note
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rose 6.7 basis points on Wednesday to 4.625%, the highest level since Oct. 16, 2007 based on 3 p.m. Eastern Time levels, according to Dow Jones Market Data.