US Bonds

Bonds ETFs - Hedge against recession

Hedge against recession

In times of recession, the financial markets often experience a significant downturn, leading to a general decline in asset prices. This can include stocks, real estate, and even some commodities. However, there are alternative investment options that tend to perform well during economic downturns, such as buying bond exchange-traded funds (ETFs) like SHY, IEI, and TLT.

  • SHY (iShares 1-3 Year Treasury Bond ETF): SHY is composed of short-term U.S. Treasury bonds, which are considered one of the safest assets during periods of economic uncertainty. These bonds are backed by the U.S. government, making them less susceptible to default risk. Investors often turn to SHY for stability and capital preservation during recessions.
  • IEI (iShares 3-7 Year Treasury Bond ETF): IEI holds intermediate-term U.S. Treasury bonds. While slightly more sensitive to interest rate changes than shorter-term bonds, they still offer a high degree of safety compared to riskier assets like stocks. Investors often seek IEI for a balance between safety and yield.
  • TLT (iShares 20+ Year Treasury Bond ETF): TLT comprises long-term U.S. Treasury bonds. These bonds tend to perform exceptionally well during recessions as they offer higher potential returns compared to shorter-term bonds. However, they also come with higher interest rate risk. TLT is favored by investors who are looking for both safety and the potential for significant capital gains during economic downturns.

How do Bonds prices behave?

During a recession, the Federal Reserve often implements policies that include lowering interest rates and increasing the money supply. These actions leads to increased prices of previously sold bonds.

When interest rates in the market decrease, the prices of bonds generally rise. This relationship between interest rates and bond prices is fundamental in the world of fixed-income investments. The reason behind this inverse relationship is relatively straightforward. Let's break it down.

Bonds pay a fixed interest rate, known as the coupon rate, to their holders. When market interest rates (also known as yields) decline, newly issued bonds tend to offer lower coupon rates to match the prevailing lower rates. However, if you already hold a bond with a higher coupon rate that was issued when rates were higher, it becomes more attractive to investors because it provides a better return compared to newly issued bonds with lower coupons.

To understand the difference in price rises among bonds with different maturities, consider this: when market interest rates drop, short-term bonds tend to experience smaller price increases compared to long-term bonds. This is because short-term bonds have less time left until they mature, and their coupon payments are relatively stable. In contrast, long-term bonds have a longer duration, meaning they have more future coupon payments that will be received at the older, higher coupon rate. As a result, long-term bonds experience more significant price increases than their shorter-term counterparts when interest rates decrease.

In summary, when interest rates fall, bond prices rise. The magnitude of the price increase depends on the bond's maturity, with longer-term bonds experiencing larger price gains due to their higher coupon payments relative to newly issued bonds with lower coupons in a lower interest rate environment.

September 2023 situational report


With current US interest rates hovering near a 25-year high at 5.5%, the prospect of the Federal Reserve (Fed) initiating a rate cut can have a significant impact on the bond market. When the Fed decides to reduce interest rates, it typically triggers an uptick in bond prices. This happens because existing bonds with higher coupon rates become more attractive to investors compared to newly issued bonds with lower coupons in the lower-rate environment. As a result, bondholders can expect to see their bond investments appreciate in value when the Fed starts to lower interest rates.