Inflation Expectations Keep Short-Term Bonds in Play

Despite the expectation of interest rate cuts, a push-pull dynamic could exist if inflation continues to be sticky. That said, short-term bond funds could remain in play if fixed income investors want to mitigate rate risk.

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MSN noted that market players are purposely keeping long-term Treasuries at bay and keeping short-term to medium-term bonds close by. The potential of higher inflation in 2025 is a prime reason for the move. That could keep the short-term bond strategy intact that was largely effective during the Fed’s aggressive rate hikes in 2022.

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As MSN explained, with elevated inflation expectations, investors will demand higher yields to counterbalance the increased rate risk associated with longer-term bonds. Adding to the uncertainty is a new presidential administration taking the helm in 2025. That could change the bond landscape from a policy perspective.

“A hawkish cut is consistent with both what the data will look like, but also potential policy changes from the new administration,” said George Bory, chief investment strategist for fixed income at Allspring Global Investments.

Fixed income investors looking to offset their long-term bonds with shorter maturity dates can look to funds like the Vanguard Short-Term Bond Index Fund ETF Shares (BSV). It’s an ideal way for investors to get ingress to short-term bonds without the complications of building their own portfolios with individual debt issues.

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BSV seeks to track the performance of the Bloomberg U.S. 1-5 Year Government/Credit Float Adjusted Index. This index includes a diverse array of bonds for added diversification. They include all medium and larger issues of U.S. government, investment-grade corporate, and investment-grade international dollar-denominated bonds that have maturities between one and five years and are publicly issued. With its low 0.04% expense ratio, BSV boasts a 30-day SEC yield of 4.37% as of December 12.

Concentrated Exposure to Short-Term Bonds

Investors looking for concentrated exposure to Treasuries but also want the rate risk mitigation component of short-term bond funds can look to the Vanguard Short-Term Treasury ETF (VGSH). The fund offers ideal exposure to short-term Treasury notes, focusing on maturity dates that fall within one to three years. It has a 30-day SEC yield of 4.28%. Like BSV, the fund also features a low 0.04% expense ratio.

For more yield while accepting more credit risk, short-term corporate bonds are available with the Vanguard Short-Term Corporate Bond Index Fund ETF Shares (VCSH). The fund tracks the the performance of the Bloomberg U.S. 1-5 Year Corporate Bond Index. The index includes U.S.-dollar-denominated, investment-grade, fixed-rate, taxable securities issued by industrial, utility, and financial companies, with maturities between one and five years. The fund has a 30-day SEC yield of 4.73% paired with the same low expense ratio of 0.04%.

For more news, information, and strategy, visit the Fixed Income Channel.