Seizing Investment Opportunities in a Rate-Cut Cycle: LQD ETF vs. Long-Term Treasury ETF — Fixed Income Product Selection and Strategy
In the current context of increasing global economic volatility and uncertainty, the direction of the Federal Reserve's monetary policy has become a focal point for the market. Especially when a rate cut cycle begins, it is often accompanied by expectations of an economic recession, posing new challenges to investors' strategies. Under these circumstances, the allocation of fixed income products becomes particularly important. Among these, the $Ishares Iboxx $ Investment Grade Corporate Bond Etf(LQD.US$ which focuses on investment-grade corporate bonds, has garnered significant attention due to its unique characteristics. This article will explore the key features of the LQD ETF and its performance in a rate-cut environment, helping investors better understand this financial instrument and providing valuable insights for future investment decisions.
This article will primarily introduce the differences between the LQD ETF and long-term U.S. Treasury ETFs.
Characteristics of the LQD ETF
The LQD ETF (iShares iBoxx $ Investment Grade Corporate Bond ETF) is an exchange-traded fund focused on investment-grade corporate bonds. Simply put, it is a basket of high-quality corporate bonds. Here are a few key features to note:
Diversified Portfolio: The LQD ETF holds bonds from various industries and companies, thereby diversifying risk. This means that the failure of a single company won't result in a total loss for the fund.
Higher Yields: Compared to government bonds, investment-grade corporate bonds typically offer higher yields, which is why the LQD ETF tends to provide relatively substantial returns. (Currently, the pre-tax yield is around 4.30%)
Credit Risk: Although the LQD ETF only selects bonds with high credit ratings, the circumstances of companies can always change. Therefore, there is some degree of credit risk involved. It performs well in the absence of a large-scale economic crisis, but if the economy continues to decline, there will be a risk of sustained decline in face value.
Interest Rate Risk: The price of the LQD ETF fluctuates with changes in interest rates. When interest rates rise, bond prices fall; when interest rates decrease, bond prices rise.
Liquidity: The LQD ETF has relatively good liquidity, but it is not as high as that of Treasury ETFs.
Differences from Long-Term U.S. Treasury Bond ETFs
Next, let's look at the differences between the LQD ETF and long-term U.S. Treasury ETFs (such as the $iShares 20+ Year Treasury Bond ETF(TLT.US$ ):
Credit Risk: Long-term U.S. Treasuries are considered low-risk products since they are issued by the U.S. government itself. While the corporate bonds in the LQD ETF are of good quality, they still carry a risk of default.
Yield: Long-term U.S. Treasuries have lower risk and, consequently, lower yields. In contrast, the LQD ETF typically offers higher yields.
Interest Rate Sensitivity: Long-term U.S. Treasuries are particularly sensitive to changes in interest rates due to their long maturity periods. Although the LQD ETF is also affected by interest rates, the impact is less severe. If you're looking to trade based on price differences, TLT (20-year Treasury ETF) is evidently more elastic.
Liquidity: Both have good liquidity, but because the LQD ETF includes a variety of corporate bonds, there might be slight differences in liquidity.
The impact of interest rate cuts on LQD ETFs
Now, let's take a look at what happens to the LQD ETF when interest rates fall. Typically, a rate cut causes the price of the LQD ETF to climb upward. why? This involves several key mechanisms:
Interest rates fall: When the central bank announces an interest rate cut, the yield on newly issued bonds decreases. This makes existing high-yield bonds more popular and prices rise, although historically the price elasticity of such bonds has not been high. (Purple line: U.S. ten-year Treasury bond yield, K line: trend of LQD ETF)
Changes in Discount Rate: The price of a bond is calculated based on the present value of its future cash flows. When the discount rate decreases, the present value of future cash flows increases, naturally driving up the bond price.
Increased Demand for Corporate Bonds: A rate cut implies potential economic recovery, reducing corporate financing costs. This boosts investor demand for corporate bonds. As a result, the bonds in the LQD ETF become more popular, leading to higher prices.
Narrowing Credit Spread: A rate cut is usually accompanied by expectations of economic recovery, which lowers the risk of corporate defaults. The yield gap between corporate bonds and government bonds (credit spread) narrows, further pushing up the prices of corporate bonds.
Reinvestment Risk: In a rate-cut environment, investors seek higher-yield opportunities. Due to its relatively higher yield, the LQD ETF becomes an attractive option. This increased demand further drives up its price.
In short, interest rate cuts usually bring benefits to LQD ETF, leading to price increases. Although the price elasticity is weak, it can play both offensive and defensive roles for investors who hope to obtain higher returns in a low interest rate environment.
Disclaimer: Moomoo Technologies Inc. is providing this content for information and educational use only.
Read more
Comment
Sign in to post a comment
Moomoo Official Account
Provide valuable insights to users
978Followers
4Following
1554Visitors
Follow