5 Bond ETFs To Watch Ahead Of The Fed's Key Interest Rate Call Wednesday

The Federal Reserve's interest rate decision on Wednesday will have major repercussions not just for the stock market, but also for the bond market.

The market is now pricing in a 25-basis-point hike to 4.75%-5% with a nearly 90% possibility, but what the Fed indicates it will do after March is what is putting investors on edge.

Since the start of the banking crisis this month, U.S. Treasury yields have dropped significantly as the market began pricing in a Federal Reserve policy shift.

With the strain still present in the banking sector, the likelihood of an overtightening has diminished significantly. The markets have already discounted two 25-basis-point of cuts by December 2023.

How Bonds Could React To Fed’s Rate Decision

If the Fed acknowledges the need to halt rising rates and even opens the door to potential cuts down the road, investors' dovish expectations will be validated. If this is coupled by a sustained decline in inflation and a recession, the ideal macroeconomic conditions for investing in bonds may be created.

On the contrary, a Fed that pushes against what the market is pricing now and re-establishes the need to keep hiking would be a drag on the bond market. If inflation continues to surge, and if the economy still holds up well despite higher rates, Treasury yields might increase further, producing downward pressure on riskier bond segments, such as corporate high yield and emerging markets.

5 Bond ETFs To Watch Ahead Of A Fed Policy Pivot

• iShares 1-3 Year Treasury Bond ETF (NASDAQ:SHY)

The iShares 1-3 Year Treasury Bond ETF is an exchange traded fund managed by BlackRock, Inc. (NYSE:BLK) that invests in U.S. Treasury securities with maturities higher than or equal to one year but less than three years.

As a result, SHY is sensitive to short-term Fed interest rate speculation, although its volatility is normally limited due to its short duration.

When an unexpected negative shock hits the market and causes the Fed to become more dovish, it's one of the assets to consider in your portfolio.

SHY has risen 1% month-to-date and attracted inflows for $876 million over the last month.

• iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT)

The iShares 20+ Year Treasury Bond ETF is an exchange traded fund managed by BlackRock that invests in U.S. Treasury securities with maturities higher than 20 years.

For this reason, TLT is extremely sensitive to medium-term Fed interest rate expectations and typically screens an elevated volatility to the rate moves given its high duration profile.

It is an asset that appreciates a lot when recessionary shocks hit the economy and cause a collapse in inflation expectations.

TLT has soared 3% month-to-date and attracted inflows for $1.3 billion over the last month. 

Read next: How to Buy Treasury Bonds

• iShares iBoxx $ Investment Grade Corporate ETF (NYSE:LQD)

The iShares iBoxx $ Investment Grade Corporate Bond ETF is an exchange traded fund managed by BlackRock that invests in investment-grade corporate bonds with at least three years to maturity.

Since LQD is invested in bonds issued by stable corporations with a high credit rating, it is a defensive asset that may be favored over Treasuries when an attractive yield differential emerges.

During periods of risk-off in the stock markets, investors often seek refuge in the fixed yields given by safer corporate bonds.

LQD has risen 2.7% month-to-date and attracted inflows for $1.02 billion over the last month. 

• iShares iBoxx $ High Yield Corporate Bond ETF (NYSE:HYG)

The iShares iBoxx $ High Yield Corporate Bond ETF is an exchange traded fund managed by BlackRock that invests in high yield corporate bonds with maturities of at least one year and less than 15 years.

Since HYG invests in junk corporate bonds, it is a riskier asset that is closely related to risk sentiment in global equity markets.

Periods of plentiful liquidity and low corporate defaults are ideal for HYG to climb, yet when interest rates rise and there is concern of widespread defaults, HYG collapses.

HYG has fallen by nearly 1% month-to-date and attracted inflows of $153 million over the last month.

Read next: How to Buy Corporate Bonds

• iShares J.P. Morgan USD Emerging Market (NASDAQ:EMB)

The iShares J.P. Morgan USD Emerging Markets Bond ETF is is an exchange traded fund managed by BlackRock International Limited and BlackRock Fund Advisors that invests in USD-denominated bonds of emerging countries across the globe and seeks to replicate the performance of J.P. Morgan EMBI Global Core Index.

EMB is also a highly volatile bond ETF that is also tightly correlated to HYG given its "risk-on" profile. Therefore, lower Fed interest rates and prospects of abundant liquidity in markets are what send EMB higher. On the other hand, higher U.S. Interest rates and rising Treasury yields represent major headwinds.

EMB has fallen by 0.5% month-to-date and registered outflows for $337 million over the last month.

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