As Treasury Bonds Face More Risks, Protect Yourself

Investors have flocked to U.S. Treasuries and bond-related exchange traded funds in a world of negative-yielding sovereign debt. However, with U.S. Treasury yields hovering around three-decade lows, government debt looks pricey and fixed-income investors are now exposed to greater risks.

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The yield on 10-year Treasury bonds closed below 1.4% for the first time ever earlier this month and has risen to 1.57%. Given the record-low yields, investors may not be receiving enough compensation for the amount of risk they are exposed to. When factoring in inflation, the real yield on 10-year Treasuries is also near its lowest since 1980. Consequently, after government bonds have become so richly valued, it is hard to justify buying into these Treasury bonds.

The economy is not spelling out a doom-and-gloom scenario. U.S. economic data has been positive over recent weeks. For instance, the number of those filing for unemployment benefits dipped to a three-month low last week, signalling further improvements in the labor market. The Producer-Price Index just registered its largest climb in a year.

Moreover, with the S&P 500 and Dow Jones Industrial Average breaking new highs, the risk-on attitude could also diminish demand for safe-haven assets, like U.S. Treasuries, raising concerns that bonds could be due for a further pullback that would push yields back above 2.0%.

Investors will want to keep an eye on the Federal Open Market Committee meeting which will release a decision on rates Wednesday. Recent Fed funds futures rates showed rising options traders’ expectation for an interest rate hike. Any hint that the Fed sees an improving economy would allow policy makers to raise rates would likely have an immediate negative effect on fixed-income assets.

Consequently, bond investors may consider inverse or bearish Treasury bond ETF strategies to hedge against further declines in the Treasuries market and rising yields.

For instance, the ProShares Short 20+ Year Treasury (NYSE:TBF) and Direxion Daily 20+ Year Treasury Bear 1x Shares (NYSE:TYBS) take the simple inverse or -100% daily performance of Treasury bonds that mature in over 20 years.

For more aggressive bond traders, the ProShares UltraShort 20+ Year Treasury (NYSE:TBT) tries to reflect the -2x or -200% daily performance of the Barclays U.S. 20+ Year Treasury Bond Index. The ProShares UltraPro Short 20+ Year Treasury (NYSE:TTT) takes the -3x or -300% daily performance of the Barclays U.S. 20+ Year Treasury Bond Index. Additionally, the Direxion Daily 20-Year Treasury Bear 3X (NYSE:TMV) tracks the -3x or -300% daily performance of the NYSE 20 Year Plus Treasury Bond Index.

Potential traders, though, should be aware of the risks associated with these geared products and keep in mind that leveraged and inverse ETFs are designed to produce their target strategies on a daily basis. Consequently, when investors look at the long-term performance of a leveraged or inverse ETF, people may notice that the funds do not perfectly reflect their intended strategies.

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