These ETFs could win big if Treasury yields continue their surge this year

Published Tue, Jan 18 20221:06 PM ESTUpdated Tue, Jan 18 20221:42 PM EST

Investors expect the Federal Reserve to boost interest rates in a major way – and today's surging bond yields reflect that prediction. Here are some exchange-traded funds that stand to benefit from the new regime. The Fed has signaled it could become even more aggressive than expected about tightening policy to tame surging inflation. Central bankers including Chairman Jerome Powell indicated they expect to hike rates and taper asset purchases soon , adding they could be gearing up to reduce their balance sheet. The market consensus right now calls for the first rate hike in March. High-profile investor Bill Ackman argued the central bank should even raise its key interest rate by a bigger-than-expected 50 basis points in the coming months. "The [Fed] could work to restore its credibility with an initial 50 bps surprise move to shock and awe the market, which would demonstrate its resolve on inflation," Ackman said in a tweet over the weekend . The stock market has been volatile in 2022 with high-flying tech stocks selling off in the face of rising rates. The 10-year Treasury yield topped 1.86% at its high on Tuesday after finishing 2021 around 1.51%. "There is every probability that rate hikes will cause significant volatility, particularly since the Fed is likely to hike rates into a slowing economy," Richard Hodges, a portfolio manager at Nomura, said in a note. Short Treasury ETFs The first category of funds that tend to gain in a rising-rate environment are the ones that bet against Treasurys. Bond yields have an inverse relationship to prices. For example, ProShares UltraPro Short 20+ Year Treasury (TTT) seeks to profit from the decline in Treasury bond prices with a maturity date of 20 years of more. Its returns are three times the inverse of the daily performance of the ICE U.S. Treasury 20+ Year Bond Index. The ETF, with an expense ratio of 95 basis points, has rallied 16% year to date amid the fall in bond prices. Hedging rising rates Some ETFs take a less aggressive approach to shorting Treasury securities. WisdomTree Interest Rate Hedged U.S. Aggregate Bond Fund (AGZD) combines a short position in Treasury notes to target zero duration with a long position in corporate bonds. This method helps mitigate overall sensitivity to rising interest rates, while maintaining traditional bond exposures. This ETF is about flat on the year. It costs 23 basis points. Another popular way to hedge interest rate risk is through floating-rate funds. For instance, iShares Floating Rate Bond ETF (FLOT) gives exposure to U.S. floating rate bonds, whose interest payments adjust to reflect changes in rates. In other words, as rates rise the bonds in the fund will have a higher yield. The ETF has an expense ratio of 15 basis points.

Traders work on the floor of the New York Stock Exchange (NYSE) January 12, 2022.

Brendan McDermid | Reuters