Low-Volatility ETFs in a Rising Rate Environment

NEW YORK (ETF Expert) -- Headline unemployment has fallen to a five-year low of 7%. The perception that job growth is strengthening may pressure the Federal Reserve to curb its program of electronically printing money ($85 billion per month) and, subsequently, purchasing U.S. bonds.

Buying government debt in various amounts since late in 2008 has had the desired effect of pushing intermediate-term bond prices higher and interest rates lower. On the flip side, curtailing the purchases in any substantive way would depress bond prices dramatically and send interest rates skyrocketing.

Here's the challenge in a pistachio nut shell. Money managers have been cutting back their allocation to U.S. Treasuries. U.S. retail investors have been pulling back on their bond fund holdings. Central banks around the world pared their exposure by $128 billion between April and August. Heck, CNBC is talking up the potential virtues of shorting the bond market.

It follows that any significant pullback by the Federal Reserve could cause a yield spike not unlike the one that occurred in the May-June period. Only this time, a dramatic jump in the cost of borrowing for consumers might not just dent the real estate revival and economic recovery at large, it could kill both.

Very few analysts agreed with me that it was unlikely for the Federal Reserve to do anything of substance in September. As it turned out, they did not take any action. In spite of those who will talk about Fed moves in December or January, I will say it again: The Fed will not make significant changes to its policy of quantitative easing until the second half of 2014 at the earliest.

Might it make a trivial gesture of slowing the monthly activity from $85 billion to $75 billion? Sure. Yet, anything that resembles a genuine directional shift could create a stampede for the exits; anything more than a Fed "nod and a wink" could choke off economic recovery entirely.

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