Bond ETFs promise stability, but they could hide the same trap as 2022. Rate cuts don’t always save those who believe in supposedly “safe” options.
When you buy an income-paying bond ETF, you think you’re choosing safety. "Stable income," "risk-free," "a haven from the stock markets." But is that really the case? Behind that comforting quarterly distribution lies a subtle technical risk, difficult to grasp at first glance.
The paradox is that many bond ETFs, despite having regularly distributed coupons for years, still show negative total returns since 2022. Yet, the dominant narrative continues to say: "When the Federal Reserve cuts rates, bonds will rise again." Is this really so obvious?
From 2022, the "forgotten lesson" of bonds
In 2022, the bond market suffered the biggest loss of market value in 40 years. Investors, believing they were seeking refuge in stability, found themselves with portfolios loaded with bond ETFs that were down by as much as 30% in value. The reason is simple but powerful: when rates rise, bond prices fall.
And the longer the duration, the steeper the fall. ETFs investing in long-duration Treasuries and corporate bonds, such as the US TLT or its European equivalent, saw yields rise to around 4–5%. But the price collapsed, and the capital loss far exceeded the distributed coupon. Many long-duration ETFs, despite having a high yield to maturity, have not yet recovered from the 2022 sell-off.
And this is the first major trap: believing that waiting for a rate cut will be enough to see the light again.
Rate Cuts? It’s not that straightforward
Many investors’ mistake is to think linearly: "If rates fall, prices rise." But the reality, especially in the United States, is more complex. The Federal Reserve controls short-term rates, not long-term rates, which depend on inflation, the deficit, foreign demand, and growth expectations. And if inflation remains high, while cuts only occur in the short term, the yield curve could simply steepen: long-term rates remain stable or even rise, and the prices of long-duration bonds remain compressed.
The risk, therefore, is that we will see a similar but opposite dynamic to that of 2022:
- short-term rates fall, but long-term rates remain stubbornly high;
- bond prices do not rise, and ETFs remain stuck in a range-bound and volatile market.
The technical problem, furthermore, is that bond ETFs don’t have a maturity: their portfolio is rebalanced (rolling). This means that the investor never receives back the nominal capital as with a single bond, but remains permanently exposed to price risk, albeit with a measurable yield to maturity (YTM).
The reinvestment or roll-down risk of bond ETFs
When you buy a bond ETF, you’re not actually buying a security that will mature in 10 years. You’re buying a portfolio of bonds that, as they mature, are replaced by new issues. This mechanism, called rolling, is a double-edged sword: it allows you to always remain invested in the same average duration, but it continually exposes you to market risk.
It’s a fundamental concept: the yield to maturity shown for an ETF is only an indicative measure, not a guarantee of real return. It helps estimate what would happen if interest rates remained unchanged and bonds were held to maturity. But in an ETF, those bonds are continually replaced, so the actual return depends on secondary market price fluctuations.
The invisible risk: duration and liquidity
There’s another often overlooked element: the effective duration of many bond ETFs. A long-duration ETF (20 years or more) reacts dramatically to any change in interest rates. This is why, even with a high coupon, the overall risk remains very high.
Furthermore, in times of stress, the liquidity in ETF trading can also dry up: the market price can diverge from the portfolio’s net asset value (NAV). In 2020 and 2022, discounts or premiums to NAV exceeding 1–2% were observed, a staggering amount for instruments that are supposed to represent stability.
Bond ETFs, ultimately, are a double-edged sword: they protect against specific risk (issuer default), but amplify systemic risk (interest rate movements and volatility).
What if 2025 isn’t the year bonds bounce back?
Current market consensus is betting on a "soft landing" and rate cuts by the Fed in 2026. But if inflation were to remain above 3% on average, or if real growth remained resilient, long-term yields could remain structurally elevated. In this scenario, many bond ETFs would remain trapped in a difficult equilibrium: attractive yields, but modest or even negative total returns.
The biggest risk is forgetting
Positive bond expectations could prove to be another illusion. It’s not a given, but it’s a scenario that shouldn’t be ruled out. Anyone who thinks that simply cutting rates can automatically "resuscitate" bond ETFs risks being disappointed: the dynamics of fixed income markets have become much more complex, especially given constant central bank intervention and the evolving shape of the yield curve. So the real question becomes: are you buying an opportunity, or déjà vu disguised as an opportunity?
Original article published on Money.it Italy 2025-10-20 05:59:00. Original title: Attenzione alla nuova trappola sugli ETF obbligazionari
