Investors Bid Up Treasury ETFs After Quarter-Point Rate Hike

Treasury exchange-traded funds jumped Wednesday after the ninth-straight interest rate hike by the Federal Reserve.

The central bank raised rates 25 basis points, less than what was expected a few weeks ago, after a series of bank collapses and rescues suggested a worrisome fragility to the U.S. and European banking sectors. The Fed at the beginning of the month was expected to raise rates by a half-percentage point as it sought to slash inflation from the current 6% to 2%.

The increase shows curbing inflation remains the Fed’s priority, according to Andrew Patterson, senior economist at Vanguard Group, the No. 2 ETF issuer.

“We agree with their assessment of the need to maintain focus on inflation with increase in rates combined with language acknowledging banking sector volatility and continued risk of inflation,” Patterson said in emailed comments to etf.com.

The hike brings the federal funds rate to between 4.75% to 5%, the highest level since 2007. Federal Open Market Committee participants reinforced their commitment to taming inflation to its 2% goal while acknowledging the effect of tightening on markets.

“Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation,” officials said in a statement. Still, they noted that rates may remain more elevated for longer than expected. Projections from FOMC officials show that the fed funds rate could reach 5.1% by the end of the year.

Broad bond ETFs, which have gained around 3% this year before the rate increase, moved higher on the news. The iShares 7-10 Year Treasury Bond ETF (IEF) rose around 1.3%, and the iShares U.S. Treasury Bond ETF (GOVT) and the Vanguard Total Bond Market ETF (BND) both added one percent.

Stock ETFs declined after initially rallying. The SPDR S&P 500 ETF Trust (SPY) dropped 1.7% while the Invesco QQQ Trust (QQQ) slipped 1.4%, in correspondence with their underlying indexes. Meanwhile, the yield on the 10-year Treasury bill fell 15 basis points to 3.45%, while the policy-sensitive two-year note dipped 22 basis points to 3.96%. Bond yields fall as prices rise.

In comments after the rate hike announcement, Fed Chairman Jerome Powell reiterated the U.S. banking sector is strong, while also suggesting the impact from collapses and bailouts remains to be seen.

“We are committed to learning lessons from this episode,” he said, adding that recent events in the banking system are “likely to result in tighter credit conditions,” but its future impact on the economy and monetary policy remain unclear.

Bank ETFs have been beaten down over the past four weeks: the $3.1 billion SPDR S&P Regional Banking ETF (KRE) is down 30%; the $1.3 billion SPDR S&P Bank ETF (KBE) lost 26% and the iShares U.S. Regional Banks ETF (IAT) dropped 32%.

Patterson said that it is “also clear that inflation remains the priority despite pain in the banking sector caused by higher rates based on statement language tweaks and forecast changes,” but maintained that there may be a recession in the second half of the year.

Before the rate hike, investors poured into both SPY and Treasury-linked ETFs. More than $10 billion went into SPY between March 13 and March 21. Meanwhile, IEF, GOVT and BIL hauled in $8.7 billion during the same period, according to etf.com data.

Contact Shubham Saharan at [email protected]