SGOV Will Let Yield Get Away

The iShares 0-3 Month Treasury Bond ETF (NYSEARCA:SGOV) is an ETF for fixed income speculators to play on when duration is unattractive as well as high credit risk. Backed by the US government and with very short durations, the yields are going to be whatever the spot rates are. As the rate cycle picked up, SGOV made sense, but our house view is that rates are peaking. What’s more is that a soft landing continues to be indicated my macro data. We think investors can afford to get more aggressive than SGOV.

SGOV Key Data

SGOV carries virtually no credit risk, containing just US government securities. What makes SGOV special is that it only carries short term bonds, so in addition to no credit risk there’s no duration risk either. Duration risk is the risk of a bond’s price in relation to a change in interest rates. Usually, fixed income instruments’ value declines as rates rise, because the bonds were priced at par at prevailing rates that were lower than where they’re going and therefore must go lower. SGOV does not have this issue as bonds keep maturing and rolling over into the higher spot rates, yielding more or less whatever the prevailing rate is for short term government securities. In a rising rate environment, nothing is better than SGOV at this level of AAA credit risk, but in a lower rate environment, it’s not as attractive.

Alternatives

We think that in all likelihood, interest rate cycles are peaking soon. We also think, although with less confidence, that there will be a soft landing. Rates will likely peak because we are about lap the period where the real inflation started. Moreover, economic trouble in about 30% of the world’s economy, not the US, takes pressure off prices in globally priced commodities. Finally, the higher rates are cooling demand in the US as well. Inflation expectations aren’t high, and that’s essential for reducing risk of a wage price spiral. Soon there will be no reason for more rate hikes.

Soft landing speculation comes from a similar point of view. Firstly, markets are unlikely to acknowledge the better hand of the US over other economies, and the game theory around how other economies will have to fold their economies first thanks to US exorbitant privilege and geopolitical power in playing the Ukraine war. The other thing is the jobs data, which shows that jobs growth is still solid despite months of higher rates and the beginning of layoffs but in limited parts of the economy. The big recession danger is an earnings decline-unemployment spiral. It doesn’t seem that will happen as corporate performance is still rather good. Moreover, the continued jobs growth is also coming with less wage inflation, which is essential for the aforementioned peak rate argument.

In light of this, fixed income investors might consider ETFs that are longer duration and higher credit risk. We recently covered the iShares 0-5 Year High Yield Corporate Bond ETF (SHYG) which features a higher credit risk, more in junk territory. The issue there was that duration could have been higher at only 2.5 years. To make a higher conviction bet on thesis above, investors could consider portfolios with the same yield and credit risk but a more aggressive duration profile like the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) which has a 4-year duration.

All in all, SGOV is a little too passive and lazy as far as macro is being telegraphed. Investors can afford to act on the data that the market seems to be ignoring.

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