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【Bond ETF】Interest Rate Reduction Expected, Can Watch These US Bond ETFs

Since this year, the movement of the US stock market has been clearly influenced by the market forFed Rate Reduction ExpectedImpact. Following the conclusion of the Federal Open Market Committee (FOMC) meeting on March 21, the Fed formally announced that it would keep interest rates unchanged, releasing potential signals to markets that three rate cuts could take place during the year. If the rate cuts are implemented in the run-up to the US election, it will significantly boost the bond market, which has been covered by the glow of the stock market during the previous rate hike cycle.

Interest rate bitmap comparison
Interest rate bitmap comparison

Source: US Federal Open Market Committee (FOMC)

Impact of interest rate reductions on bond prices

Imagine that you have a loan in your hand, which is like a bond, on which it says that someone has lent you 100 pieces of money and promises to give you a certain interest every year. Now that borrowing rates have decreased throughout the market, which means that now someone else just has to pay a lower interest rate than before if they want to borrow money.

That way, the bond you hold that promises to pay higher interest rates becomes a steal. Because your bonds are more profitable than newly issued, lower-interest bonds. So, if someone else wants to get that income, they're willing to pay more than the bond's face value to buy your bond, causing the price of the bond to rise.

For longer-term loans, those bonds that take longer to mature are more sensitive to changes in interest rates. When interest rates fall, the price rise of long-term bonds tends to be greater. This is because for long-term bondholders, the future cash flow of a relatively high fixed rate increases its value more significantly, so investors are more willing to buy long-term bonds at higher prices, further driving up their market prices.

All in all, when interest rates fall, bond prices generally increase, and the longer the maturity of bonds becomes more variable.

Reverse changes in bond prices and interest rates
Reverse changes in bond prices and interest rates

Source: Macromicro

Currently, the price of US Treasury bonds has fallen to relatively low positions due to the Fed's continued interest rate hikes. If the future Fed successfully enters a rate-cutting cycle, the overall level of market interest rates will fall, and the yield on newly issued Treasuries will also decrease. As a result, the relatively high yield of old bonds in the past quickly became a sensation, and investors sought these bonds that were able to lock in higher yields, driving the price of bonds back up.

At the same time, yields on long-term bonds tend to go down when the Fed cuts interest rates, which is like telling everyone that the future economy may be less optimistic, and longer-term bonds as a relatively safe investment grade are more popular at lower rates. Therefore, once the interest rate reduction policy is actually in place, it can be expected that the market will see a wave of upward momentum in Treasury prices.

Bond ETF: Propeller for Interest Rate Downturn

Direct Investment Bonds vs Investment Bonds ETFs

For the average investor, investing in bond ETFs will be somewhat more convenient. The greatest advantage of bond ETFs is that investors can avoid the hassle of choosing specific bonds and directly hold different types of bonds at low cost to achieve the purpose of diversifying investments.

BONDS AND ETFS ARE ESSENTIALLY TWO COMPLETELY DIFFERENT TYPES OF TRANSACTIONS, BUYING A BOND CAN BE HELD TO MATURITY, BUT AN ETF IS ESSENTIALLY A FUND AND THERE IS NO “MATURITY” SO WHAT TO DO WHEN THE BOND IN THE ETF POSITION MATURES? Actually there is no need to worry about this issue at all:

Suppose you bought an investment of more than 20 yearsU.S. TreasuryIn ETFs, ETF issuers check their positions every once in a while, sell some bonds that are less than 20 years away from their maturity date, and exchange them for new ones.

Based on this characteristic, the interest rate risk faced by bond ETFs is relatively high. However, if the purpose of investing in a bond is only for a stable interest rate, then you can still hold the maturity and changes in interest rates will not have an impact.

In addition to the above two points,Investment BondsAND INVESTMENT BOND ETFS, RESPECTIVELY, ARE:

  • Dividends are different; investment bonds typically pay 1~2 times a year, and investment bond ETFs typically pay monthly;

  • Trading threshold requirements and fees are different; investment bond fees include commissions, custodial fees, etc. The fees for investing in bond ETFs are the same as those for trading stocks, and an administration fee is required.

However, due to the characteristics of this type of investment, bonds or bond ETFs are suitable for long line investments and not for frequent short term trading (with the exception of leveraged and reverse ETFs).

Which Bond ETF Products to Choose

U.S. Treasury ETF

1. $iShares 20+ Year Treasury Bond ETF(TLT.US)$: TLT is an ETF that tracks long-term US Treasury performance, primarily investing in US government bonds with outstanding maturities of more than 20 years. As a long-term Treasury ETF, TLT yields are closely related to the movement of long-term interest rates and often perform well in the event of rising market risk-averse sentiment or anticipated future rate declines. It provides an effective tool for exposure to long-term interest rate risk, suitable for investors looking for stable cash flow and hedged asset allocations.

  • Advantages: High liquidity provides investors with a simple and effective way to get returns on the long-term US bond market, with lower linkages between bonds, making the portfolio more diverse.

2. $SPDR Bloomberg Barclays 1-3 Month T-Bill ETF(BIL.US)$: BIL IS AN ETF THAT TRACKS SHORT-TERM U.S. BOND INDEX PERFORMANCE, PRIMARILY INVESTED IN U.S. GOVERNMENT-ISSUED BONDS WITH A REMAINING MATURITY OF NO MORE THAN 1 YEAR. Since investments are short-term Treasury bonds, BIL has relatively low volatility and can be used as a configuration option as a cash management tool or as a lower-risk part of a portfolio

  • Advantages: Low risk, low volatility, stable returns for investors and high liquidity.

  • Disadvantages: Compared to long-term bonds, short-term bonds have limited capital appreciation when interest rates are lowered, so higher total returns may not be obtained.

3. $iShares U.S. Treasury Bond ETF(GOVT.US)$: GOVT IS AN ETF THAT COVERS ALL TYPES OF MATURITY BONDS ACROSS THE ENTIRE U.S. BOND CURVE, DESIGNED TO REFLECT THE OVERALL PERFORMANCE OF THE U.S. BOND MARKET. BY INVESTING IN TREASURY BONDS OF DIFFERENT YEARS, THE GOVT IS ABLE TO PROVIDE INVESTORS WITH COMPREHENSIVE RISK EXPOSURE TO THE U.S. BOND MARKET, EFFECTIVELY DISPERSING RISKS OVER DIFFERENT MATURITIES.

  • Advantages: Treasury bond investment maturities are spread, making it a good choice for investors who want to participate in the entire US bond market and manage risk.

  • Disadvantages: Due to the inclusion of various maturity bonds, their yield performance is influenced by the market's demand for different maturity bonds, unlike the strategy of a single term Treasury ETF is clear.

4th. $iShares 7-10 Year Treasury Bond ETF(IEF.US)$: IEF is an ETF that tracks mid-term U.S. Treasury indexes that invests in 7- to 10-year U.S. Government bonds for the remainder of the year. Compared to long-term Treasury ETFs such as TLT, IEF is moderately affected by interest rate movements, with some room for yield upside and some degree of resistance to rate risk.

  • Advantage: Medium-term Treasury ETFs strike a balance between yield and safety, especially for investment configurations when the interest rate outlook is uncertain.

  • Disadvantages: In extreme interest rate environments, whether they rise rapidly or fall sharply, they may not perform well with ETF products that are dedicated to betting on long, short-term interest rate directions.

5. $Short-Treasury Bond Ishares(SHV.US)$: SHV IS ALSO A SHORT-TERM U.S. TREASURY ETF THAT INVESTS IN U.S. GOVERNMENT BONDS WITH AN AVERAGE REMAINING MATURITY OF LESS THAN 1 YEAR. SHVs are ultra-short-term bond funds with virtually no credit risk and extremely low interest rate volatility. They are a good cash management tool and a safe haven asset.

  • Advantages: Extremely low volatility and risk, especially as a haven for capital during market volatility.

  • Disadvantages: Lower potential returns and cannot bring significant capital gains to investors.

6. $Schwab Strategic Tr Intermediate-Term Us Treasury Etf(SCHR.US)$: SCHR IS A SHORT-TERM U.S. TREASURY ETF OFFERED BY CHIACIN BANKING THAT INVESTS IN U.S. TREASURY BONDS THAT ARE LESS THAN ONE YEAR AT MATURITY. The ETF aims to provide returns close to those of money market funds while maintaining higher liquidity than money market funds.

  • Advantages: Extremely low level of risk, high liquidity, and relatively stable returns are ideal tools for short-term asset hedging.

  • Disadvantages: During a rising interest rate cycle, its earnings growth is slower and may be lower than some higher-risk fixed income products.

U.S. Treasury Bond ETF

7. $S&P National Amt-Free Muni Bd Ishares(MUB.US)$: MUB is an ETF focused on the U.S. municipal bond market that invests in tax-free state and local municipal bonds. These bonds are often used to finance public works and infrastructure, and interest income is exempt from federal income tax for qualifying investors.

  • Advantages: For investors seeking a stable income and looking to reduce their tax burden, MUB is an ideal choice, especially under higher marginal tax rates.

  • Disadvantages: Although the credit risk of municipal bonds is relatively low, it is not absolutely zero risk, and there is still the possibility of default on individual municipal projects. In addition, the tax advantage may weaken if investors are not required to pay federal income tax or lower tax rates.

US Corporate Bond ETF

8. $Ishares Iboxx $ Investment Grade Corporate Bond Etf(LQD.US)$: LQD is an investment-grade corporate bond ETF that tracks the performance of the iBoxx USD investment-grade corporate bond index. The ETF holds the bonds of large, reputable companies, which often have solid finances and high credit ratings, providing investors with a relatively stable and higher-yielding investment channel than government bonds.

  • Advantages: Because of investing in investment-grade corporate bonds, LQDs are less risky than high-yield bonds, but still provide a certain level of return. It is a suitable tool for investors looking to increase fixed income and moderate risk exposure.

  • Disadvantages: Although credit risks are relatively low, an economic downturn or worsening of individual companies' financial situation may result in credit downgrades, affecting the performance of LQD. In addition, the credit risk of corporate bonds is always present compared to government bonds.

9. $Ishares Iboxx $ High Yield Corporate Bond Etf(HYG.US)$: HYG is a high-yield corporate bond ETF that invests in the non-investment grade or “junk bond” market. These bonds typically come from companies with lower credit ratings, but they offer higher box office rates to attract investors.

  • Advantages: HYG provides investors with higher yield potential from investment-grade bonds, which can be an important source of increased portfolio returns, especially in a poor interest rate environment.

  • Disadvantages: High yield bonds have a higher credit risk, and the risk of default increases significantly, especially during economic downturns. In addition, volatility is relatively high due to its price sensitivity to market sentiment and interest rate changes. Under adverse conditions, the value of such bonds may shrink significantly.

ETF Tax Issues

Non-US tax resident investors are not subject to capital gains tax levied by the US. If non-US tax resident investors hold US bonds directly, no interest tax is required, whether US Treasury bonds, local government bonds, or ordinary corporate bonds.

However, if it is a US bond held through a bond fund or bond ETF, the interest paid by that fund or ETF is treated as dividends and is subject to tax at the rate of the dividend tax.

The tax relationship between livestock and the tax refund practices of Futubull can be referenced from the official teaching:ETF Tax Refund Guide

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