Specialized Bond ETF Thriving As Rates Rise

| About: iPath U.S. (STPP)

Fixed-income ETFs are getting hammered across the board as interest rates rise and speculation heats up that the Federal Reserve will taper its purchases of Treasuries and mortgages.

However, one specialized bond ETF is rallying as long-term interest rates rise faster than short-term rates.

The iPath US Treasury Steepener ETN (NASDAQ:STPP) has gained over 20% the past three months.

When the yield curve steepens, it means the spread between yields on short-term bonds and long-term bonds is increasing. When the curve flattens, then the gap is narrowing. STPP performs well when the yield curve is steepening.

Indeed, bond ETFs with longer durations have been hit the hardest the past few months as Treasury yields rise.

The iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT) has declined 12.2% over the past three months and is now hovering around multi-year lows.

The yield on benchmark 10-year Treasuries reached 2.88% Monday, its highest level since 2011. Meanwhile, the yields on 30-year Treasuries are back up to 3.9%.

"Ten-year yields have moved out of the range they've been in since mid-2011. You've broken that technical support level," Michael Cloherty, head of U.S. interest-rate strategy at RBC Capital Markets, said in a MarketWatch article.

The sudden spike in Treasury yields is attributed to the growing tapering fears that the Fed could cut back on its accommodative stance as soon as September.

"The biggest risk to the bond market and our tactical bullish trades is the combination of runaway tapering fears and the changing of the guard at the Fed to a more hawkish chairperson," George Goncalves, head of interest-rate strategy at Nomura Securities, said in the article.

STPP tries to reflect the performance of the Barclays US Treasury 2Y/10Y Yield Curve Index, which captures the returns that are available from a "steepening" U.S. Treasury yield curve. The ETN has a 0.75% expense ratio.

The curve steepener trade utilizes derivatives, or futures, to capitalize on a widening yield difference that occurs due to an increasing yield curve between two Treasury bonds with varying maturities. The fund takes a weighted "long" position in 2-year Treasury futures contracts and a weighted "short" position in 10-year Treasury futures.

iPath US Treasury Steepener ETN

Max Chen contributed to this article.

Full disclosure: Tom Lydon's clients own TLT.

Disclosure: I am long TLT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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