The release of the monthly Federal Reserve meeting minutes threw bond ETFs for a loop on Wednesday as investors digested the news.
Key announcements included a $10 billion per month reduction in purchases of treasuries and mortgage-backed securities along with a consensus that the Fed would begin tightening monetary policy by 2015.
The hardest hit area of the interest rate curve was in the 10-Year Treasury Note Yield (NYSE:TNX) which rose sharply on Wednesday to a closing level of 2.77 percent.
That in turn prompted a strong downward thrust in the iShares 7-10 Year Treasury Bond ETF (NYSE:IEF) along with complimentary moves in the iShares TIPS Bond ETF (NYSE:TIP) and iShares Investment Grade Bond ETF (NYSE:LQD).
All of these bond ETFs are focused on intermediate duration fixed-income securities with high credit ratings which makes them more susceptible to interest rate risk than a short duration fund.
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Investors are clearly nervous that the reduction in quantitative easing efforts is going to lead to higher interest rates and further economic guidance by the Fed may prompt them to tighten policy faster than expected.
If that is the case, the key area to watch for fixed-income investors will be 3.0 percent on the 10-Year Treasury Yield, as that was the prior high that was established at the end of 2013. A break above that level would likely lead to another wave of selling in fixed-income and investors moving to rising rate funds such as the ProShares Short 20+ Year Treasury Bond ETF (NYSE:TBF) for protection.
On the flip side, a slowdown in economic activity or equity momentum may send money pouring back into save haven assets such as treasury bonds to counteract those threats.
The one thing to be cautious of is to not get too caught up in the initial reaction to the Federal Reserve meeting as a trading trigger. Often times these days are characterized by swift moves in stocks, bonds, and gold which can change dramatically in the coming weeks.
Keep in mind that 2014 has been characterized by sentiment changes across many asset classes and additional volatility can be expected moving forward.
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