By Ambrose O’Callaghan
The United States Federal Reserve (the “Fed”) slashed its benchmark interest rate by 50 basis points on September 18, 2024. This was the first rate cut from the Fed since it embarked on its interest rate tightening path in March 2022. The Fed instituted this policy to beat back runaway inflation that had taken hold after roughly two years of aggressive monetary easing and fiscal stimulus during the COVID-19 pandemic.
So, where does this leave investors as we approach the final two months of an eventful 2024?
As short-term rates decline, investors and advisors alike might look to move from cash products, like High Interest Savings Accounts, into equities and covered call ETFs for higher income.
How do Fed rate decisions impact bond and US Treasury yield?
The September Fed interest rate cut does not necessarily mean that longer term rates will come down to track with it. On the contrary, long-term rates had already come down prior to the Fed rate cut. That is because the rates at varying maturities move up and down based on market expectations. The Fed interest rate cut was already priced in by the mid-to-late spring season.
As the chart below illustrates, bond yields moved sharply lower despite the Fed not officially cutting from April through September.
Source: Bloomberg, US Government Yield Curve, October 24, 2024
More recently, longer term rates have been rising. That has applied pressure to long-term bond prices.
Source: Bloomberg, US Government Yield Curve, October 24, 2024.
This trajectory for longer term bond prices is due to many factors. For example, stronger than expected economic data that has been released in the early fall season. This suggests that interest rates are going to stay higher across the yield curve. Meanwhile, there is some speculation that the presidential policies being discussed will stand to increase inflation and, once again, apply upward pressure on long-term rates.
Earlier this month, we’d covered why longer-term bonds and bond funds were in the spotlight after the Fed moved forward with its interest rate cut.
Where are rates and bonds headed going forward?
We have highlighted that we have transitioned from an interest rate hiking cycle to an easing cycle. Of course, there are many variables dictating the outcome of a soft landing or a hard landing. Meanwhile, investors should continue to expect market volatility and an environment that will be highly sensitive to economic data sets.
This has remained the case in the present. Moreover, the recent market dynamics have served to push volatility up from already elevated levels, as the chart below illustrates.
ICE BofA | Proxy for Bond Volatility
Source: Bloomberg, October 24, 2024.
US Treasuries and high income from covered calls | HPYT and HPYM
Harvest ETFs applies an active covered call writing strategy on its stable of Income ETFs. By writing call options at varying levels, our portfolio management team can generate high income every month from option premiums. As volatility rises, option premiums tend to increase.
There will be volatility when investing in a bond-focused covered call writing strategy. Moreover, that strategy will forego some of the upside as interest rates continue to decline. However, the trade-off in this strategy is that it generates attractive cash-flow from option premiums. That can translate into high monthly income that is also tax efficient.
The Harvest Premium Yield Treasury ETF (HPYT:TSX) offers access to high-quality US Treasury bonds via US-listed ETFs. That portfolio is overlayed with an active covered call strategy. HPYT has delivered monthly cash distributions of $0.15 per unit every single month since its launch. This represents a current yield of 17% as at October 31, 2024. That works out to $1.95 in total distributions paid per unit over that 13-month period.
Source: Harvest Portfolios Group, Inc. November 2024.
Annualized Performance
As at November 30, 2024
In January 2024, we launched the Harvest Premium Yield 7-10 Year Treasury ETF (HPYM:TSX). This fixed income ETF offers access to high-quality mid-duration US Treasury bonds via US-listed ETFs. It is overlayed with an active covered call strategy that has generated monthly cash distributions of $0.08 per unit over its lifespan.
Disclaimer:
Commissions, management fees and expenses all may be associated with investing in Harvest Exchange Traded Funds (managed by Harvest Portfolios Group Inc.). Please read the relevant prospectus before investing. The indicated rates of return are the historical annual compounded total returns (except for figures of one year or less, which are simple total returns) including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. The funds are not guaranteed, their values change frequently, and past performance may not be repeated. Tax investment and all other decisions should be made with guidance from a qualified professional.
The current yield represents an annualized amount that is comprised of 12 unchanged monthly distributions (using the most recent month’s distribution figure multiplied by 12) as a percentage of the closing market price of the Fund. The current yield does not represent historical returns.
