At Cato Institute Monetary Policy Conference this month we received another signal of what to expect at the next Fed meeting. Rates will continue to climb sharply, probably another 75 basis points. If the stock markets are aware of this with its latest hike is unclear as they have gotten carried away several times over the past few months of rate hikes. Either way, duration continues to be your enemy, so we identify another ETF, the BlackRock Ultra Short-Term Bond ETF (BATS:ICSH), to use as a sink of interim funds while waiting for another stock market reversal, or keep looking for the next high-conviction idea that can withstand the current whirlwind of market forces. It offers benchmark rates at per-minute charges and is in a market with some liquidity.
ICSH Key Features
The durations are really short. They average an effective maturity of 0.4 years thanks to a large representation of commercial paper in the mix, and YTMs match benchmark rates almost exactly at around 3.26%. Fees are low on the ETF at around 0.08%, which doesn’t eat into the return.
The issuers are in fact all companies. Credit quality is decent, but not fantastic, with most rated around A. Indeed, this is consistent with the shape of the yield curve. A YTM of 3.26% incorporates a credit risk premium, as it would normally not be the same rate as 10 Y Treasury bills which carry more duration risk in a volatile rate environment. All companies are US and all denominations are in USD, so there is no exchange rate risk to speak of, and it is questionable whether there should be a significant credit risk premium, as many issuers are financial companies, with 20% of the ETF being financial commercial papers.
More importantly, ETF liquidity is abundant.
Millions of units of the ETF are traded daily, so the market value of the exchange is well into the tens of millions of dollars. Functionally, the ICSH can serve as money market exposure for your portfolio and is a great way for conservative investors to react to the current rate environment. Core inflation continues to be at relevant numbers since last month. The headline figure has come down, but long-term high underlying inflation rates are still a problem, as inflation will spread through the economy through the price-wage mechanism. To be properly addressed, demand and employment must cool down. Indeed, Powell’s comments are also consistent with employment reports. Unemployment increases but only due to greater participation in the workforce. Jobs continue to be created.
Investors need to react to duration risk, especially as more money flows into bond ETFs as a catalyst for revaluation. Consider that preferred stocks also have duration exposure and could be part of your typical income portfolio. Duration increases your portfolio’s sensitivity to rate increases, and rate increases will continue until inflation is completely crushed. There’s a reason why in Europe it’s the ECB’s ONLY mandate, it’s spreading and dangerous, and the fact that the economy still looks healthy in the US despite the current rate hikes just means that the Fed has all the more leeway to raise rates without risking contagion or sudden shocks to incomes. One of the reasons conditions favor more rate hikes before the economy hurts than normal has to do with the housing market which is pretty rich in stocks right now. Admittedly, the years of revised regulations following the financial crisis are partly responsible for this. Benchmark rates could double further from here before inflation takes charge. Duration is your enemy, and ICSH is not exposed to duration. A good intermediate sink for funds in the current environment.
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