With only a few trading days left before March, major equity benchmarks were headed for a monthly loss, but bonds had outperformed U.S. stocks thus far in February.
An exchange-traded fund that offers wide exposure to the U.S. investment-grade fixed-income market, the iShares Core U.S. Aggregate Bond ETF AGG, has returned 1.8% so far this month as of Tuesday. In contrast, as investors have processed recent indications of softness in economic data and business earnings outlook, the S&P 500 index SPX has down 1.4% so far in February.
Although the well-liked core-bond ETF might be acting as a buffer for portfolios this month, its substantial exposure to long-term Treasurys makes it vulnerable to fluctuations in a market where inflation stays above the Fed’s 2% objective. “On days when inflation data surprises Wall Street in either direction, long-duration bonds run the risk of moving with equities,” said Rick Rieder, chief investment officer of global fixed income at BlackRock.
In a phone conversation, Rieder stated, “The idea of long-term interest rates as a hedge is outdated.” “I don’t really see the long end as a hedge.”
“Using the front to the belly of the yield curve,” Rieder stated, is how he like to construct a bond portfolio.
This entails purchasing bonds with shorter maturities. For instance, according to information on BlackRock’s website, Rieder actively manages the iShares Flexible Income Active ETF BINC to invest across a variety of global fixed-income market segments over an effective term of approximately three years.
He said that the iShares Flexible Income Active ETF is currently yielding about 6.5%. “With the yield curve this flat, you get so much yield sitting in the front to the belly,” he said. “If the economy softens, that’s where the curve will perform the best.”
According to Dow Jones Market Data, the yield on the long-term 10-year Treasury note BX:TMUBMUSD10Y dropped to 4.297% on Tuesday, the lowest since December 11 based on 3 p.m. Eastern time levels. That rate is just little higher than Tuesday’s yield of 4.097% on the 2-year Treasury note BX:TMUBMUSD02Y.
Concerns about inflation
The Fed’s favored inflation indicator, the personal-consumption expenditures index, will provide investors with a new reading on U.S. inflation in January this week. On Friday, the final day of February, the PCE report will be made public before to the opening bell of the U.S. stock market.
Major market indexes largely fell earlier this month as Wall Street was taken aback by a more aggressive-than-expected reading on U.S. inflation in January from the consumer-price index on February 12. The iShares Core U.S. Aggregate Bond ETF lost 0.5% that day, as did other exchange-traded funds (ETFs) that track the U.S. investment-grade bond market, a common core fixed-income holding.
Bond prices suffered as Treasury yields rose in response to the better-than-expected CPI inflation estimate. That day, long-duration bonds were especially erratic.
According to FactSet data, funds that invest in long-term Treasurys witnessed steep declines on February 12; the Vanguard Long-Term Treasury ETF VGLT fell 1.3%, while the iShares 20+ Year Treasury Bond ETF TLT fell 1.4%. Those losses were more than the 0.3% decline in the S&P 500 that same day.
On February 12, the iShares Flexible Income Active ETF, which has mostly concentrated on shorter-duration securities, underperformed the iShares Core U.S. Aggregate Bond ETF by a 0.1% decline.
“The iShares Flexible Income Active ETF has benefited from a portfolio of shorter-duration securities, so its maximum drawdowns have generally tended to be less dramatic than the index tracked by the iShares Core U.S. Aggregate Bond ETF,” Rieder said.
According to data on BlackRock’s website, the iShares Core U.S. Aggregate Bond ETF has a substantial exposure to long-term Treasurys, but its effective length shakes out to nearly six years.
Cross-currents
Beyond inflation, investors are negotiating crosscurrents that could influence Treasury yields and bond holding values.
In a note sent on Tuesday, rate analysts at TD Securities stated, “Treasuries have rallied significantly in recent weeks, moving from the 2025 yield highs set in mid-January to year-to-date lows.” They added that worries that tariffs might hinder growth have caused yields to decline. “The move has been choppy owing to significant market uncertainty on trade, immigration, and fiscal policy,” they said.
Read: Concerns over Trump tariffs and inflation cause consumer confidence to plummet to an eight-month low
The U.S. economy has been running at a “very strong” level from which it is currently “moderating,” Rieder said, despite the recent decrease in Treasury yields due to “some pockets of softness” in economic data and expectations in quarterly earnings reports.
The U.S. services sector flash estimate from S&P Global on Friday was lower than what Wall Street had anticipated. Regarding corporate earnings, Ford Motor Company (F) in early February set a quarterly sales record but gave a lower estimate for the year, while retail behemoth Walmart Inc. (WMT) last week gave mediocre guidance.
“It’s not worth overreacting” to the larger economic backdrop that has included wage growth and expectations for a large amount of capital expenditures by Big Tech companies, but it makes sense “to open one eye towards some data that was a bit more mixed than we anticipated,” Rieder said.
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In the meantime, the Bureau of Economic Analysis estimated on Jan. 30 that the U.S. real gross domestic product grew at an annual rate of 2.3% in the fourth quarter. Additionally, as late as February 19, the GDPNow model from the Federal Reserve Bank of Atlanta predicted that the United States was growing at an annual pace of 2.3% in the first quarter of 2025.
However, Rieder said investors would seek a higher term premium for the highly anticipated 10-year Treasury note due to worries about the huge U.S. deficit.
This implies that the 10-year Treasury rate could rise above its present levels, which could result in losses when bond yields and prices move against each other. According to Rieder, the present trading range of the 10-year Treasury yield might reach a high of about 5%.
He stated that “variables are much higher than we’ve been used to for a long time” and that investors are modeling for growth and inflation, which has left markets struggling with a great deal of uncertainty this year.
The Fed is on pause, while the ECB might “persistently” reduce
With a portfolio that extends beyond the main U.S. investment-grade market, Rieder is actively managing risks associated with fiscal and monetary policy, such as concerns about growth and inflation.
Rieder stated, “I think Europe is growing just slow enough to be really attractive,” going on to speculate that the European Central Bank would be “cutting rates persistently this year.”
Agency mortgage-backed securities, high-yield corporate bonds in the United States and Europe, securitized assets like collateralized loan obligations and commercial mortgage-backed securities, and European investment-grade corporate bonds are among the diverse holdings of the iShares Flexible Income Active ETF.
According to Rieder, “we buy a lot of European investment-grade,” with United States investors profiting from the “currency swap.”
According to FactSet statistics, the iShares Flexible Income Active ETF had a 5.8% total-return return in 2024. After a 1.3% increase last year, the iShares Core U.S. Aggregate Bond ETF trailed behind.
The iShares Flexible Income Active ETF is heavily exposed to high-yield corporate bonds, which are riskier and have ratings below investment-grade but yield higher income levels. According to Rieder, the fund’s less hazardous holdings reduce the portfolio’s overall volatility, making its maximum drawdowns less severe than those of trash bonds in general.
According to him, the Fed halted its interest rate reductions last month, keeping rates at levels that are appealing to fixed-income investors. According to Rieder, investors don’t have to aim for profits in the riskiest sectors of the high-yield market.
In the United States, sticky inflation “leaves you in a place where the Fed just can’t do anything for a good deal of time,” he concluded. “You need two months of softer labor data to get there.”
