The Federal Reserve increased its benchmark interest rate by 25 basis points last week, marking its first rate hike in three years. The unanimous decision lifted the target range to 3.75-4% from 3.5-3.75%, as policymakers sought to contain persistent inflation amid rising oil prices and renewed tensions in the Middle East.
Inflation Outlook Deteriorates
Policymakers raised their inflation forecasts, with headline inflation now expected to reach 3.7%, up from 3.6% previously. The core inflation forecast, which excludes food and energy prices, was lifted to 3.4% from 3.3%. The projections suggest that inflation will not return to the Fed’s 2% target until after 2028.
Fed Forecasts Another Rate Increase
With the economy operating near full employment, Fed chair Warsh said that the Fed could address inflation without weakening economic growth or the labor market.
The Fed’s updated Summary of Economic Projections points to an additional rate hike in 2026. Twelve officials now anticipate two rate hikes in 2026, while four project three increases and two expect just one, as mentioned on Yahoo Finance.
The median projection calls for rates to remain unchanged in 2027 following the expected increases this year, before one reduction in 2028.
Bond ETFs to Benefit
Against this backdrop, below we highlight a few bond ETFs that could benefit going forward.
iShares 0-1 Year Treasury Bond ETF SHV
We believe cash and short-dated fixed income may play a greater role in adding stability to a portfolio. SHV benefits from rising rates mainly because it holds very short-term U.S. Treasuries. The fund tracks Treasuries with maturities of one year or less, and its effective duration is only about 0.27 years, so its price is relatively insensitive to rate increases.
Also, short-term bond yields will rise alongside the Fed rate hikes. Thus, rising short-term rates can help SHV’s yield increase quickly, while its short duration limits price declines. SHV charges 15 bps in fees and yields 3.70% annually.
iShares Floating Rate Bond ETF FLOT
The floating rate bond has been an area to watch lately amid rising rate environment. Floating rate bonds are investment grade and do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of issuers.
Since the coupons of these bonds are adjusted periodically, these are less sensitive to an increase in rates compared to the traditional bonds. Unlike fixed-coupon bonds, these do not lose value when the rates go up, making the bonds ideal for protecting investors against capital erosion in a rising rate environment.
The underlying Bloomberg US Floating Rate Note < 5 Years Index of the fund FLOT comprises of U.S. dollar-denominated, investment-grade floating rate bonds with remaining maturities between one month and five years. The fund charges 15 bps in fees and yields 4.34% annually.
iShares Interest Rate Hedged Corporate Bond ETF ( LQDH)
Rising interest rates typically pressure corporate bond prices. However, iShares Interest Rate Hedged Corporate Bond ETF LQDH is designed to mitigate this risk by using interest-rate swaps that generally gain value as rates rise. This hedge can help offset losses in its investment-grade corporate bond holdings, making LQDH relatively less sensitive to rising rates. The fund yields 5.80% annually and charges 24 bps in fees.
Invesco Senior Loan ETF (BKLN)
Senior loans are floating rate instruments thus providing protection from rising interest rates. This is because senior loans usually have rates set at a specific level above LIBOR and are reset periodically which help in eliminating interest rate risk. Further, as the securities are senior to other forms of debt or equity, senior bank loans offer lower default risks even after belonging to the junk bond space. Invesco Senior Loan ETF BKLN, which yields 6.39% annually, is a good pick here.
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iShares 0-1 Year Treasury Bond ETF (SHV): ETF Research Reports
iShares Floating Rate Bond ETF (FLOT): ETF Research Reports
Invesco Senior Loan ETF (BKLN): ETF Research Reports
iShares Interest Rate Hedged Corporate Bond ETF (LQDH): ETF Research Reports
This article originally published on Zacks Investment Research (zacks.com).