The Treasury Trade-Off: How to Hedge Against the Fed

U.S. 30-year Treasury yield recently hit all-time lows. The yield on 10-year Treasurys has fallen more than 10% in the past year.

Yet, despite pitiful yield and poor performance, demand for these trades continues. The obvious question is: “Why?”

You could call it a safe-haven trade. With all the market volatility these days, it’s nice to know you can lock in a certain yield for a guaranteed period of time.

Or, you could take it for what it is really worth — low interest rates are here to stay, and people are finally starting to figure it out.

Jeff Opdyke and I have been telling you for months that Janet Yellen and Co. at the Federal Reserve simply cannot raise interest rates by any significant amount.

Finally, it seems as if Wall Street is beginning to catch on.

Despite the fact that these Treasury yields are at glaringly low levels, investors are still plugging into them.

Of course, if you believed that a rate rise was coming, that wouldn’t make any sense — you’d be locking your yield in at a lower rate than you would get otherwise.

So, why are they doing it?

Simply put, the investment world is beginning to believe that nothing worthwhile is coming from the Fed.

The Federal Reserve is set to issue a press release Wednesday. If the Fed were to hint at an earlier rate rise or signal for higher rates than expected, yields on Treasurys would spike — leaving all the buyers today with significant losses.

Sure, if there was a reasonable expectation that the Fed would increase interest rates by any significant degree, it would be worth waiting before plugging into Treasurys.

With 30-year yields at all-time lows, and 10-year yields sub-2%, the only reason to get into these now would be if you weren’t expecting anything more than a marginal increase in rates.

And that’s exactly what’s happening.

There’s simply no point in waiting any longer to get into these trades, and people have figured that out. Now, Wall Street is singing to our tune: Low rates are here to stay.

That’s what’s going on, and here’s how you can play it…

Follow the Smart Money

Throughout the second half of last year, I was cautious about adding interest-rate sensitive investments. They are vulnerable to moves by the Fed, and while I expected the Fed to keep rates low, my worries were over knee-jerk reactions from Wall Street.

That’s why back in October I told you to stay away from high-yield stocks. Since then, many stocks in the high-yield sector have tanked more than 10%, with the broader ETFs down slightly.

But today, I think it’s a good time to get back in.

With Wall Street coming to grips over a lower interest rate period for an extended time, it’s time to lock in high yields from their go-to dividend sector: REITs.
REITs have been the golden child in the era of low interest rates.

As I wrote in a recent article, U.S. REITs have risen by more than 300% since the market bottomed in 2009. But they have taken a breather lately, partly from expectation of rising rates.

But now that Wall Street has figured out not to expect much from the interest-rate hike, I believe this is our opportunity to lock in a significant yield before all of the smart money pours in.

Play to the Market’s Response

One of my favorites in the sector is American Capital Agency (Nasdaq: AGNC).

The company invests in residential mortgages for which the principal and interest are guaranteed by either a U.S. government sponsored business or by a U.S. government agency. This significantly reduces the default risk of its loans, but the company still utilizes hedges to take advantage of market swings in interest rate spreads.

While the business model looks solid, it’s the yield that has put American Capital Agency high on my radar.

It is currently dishing out a 12% yield in the form of monthly dividend checks. So each month, you would receive a 1% yield without the price of the shares moving at all.

Considering we are entering a period of low rates for a long time, that’s not a bad deal.

You need a dividend payment of this size to help balance out your portfolio from the volatility in the market.

Not to mention, the REIT will see strong inflows from investors that will send its price even higher as the reality of low rates sinks in.

Either way, if you’re going to go with an investment that is backed by the U.S. government, why not lock in a substantial yield like American Capital with 12%, rather than settle for the sub-2% yields our government’s Treasurys are fetching today?

Chad Shoop Sovereign Investor
Chad Shoop
Editor, Pure Income

Leave a Reply