In recent times, the long-term Treasury exchange traded fund (ETF) known as “$TLT” was considered unexciting. It had small price movements and low trading volumes, making it appealing to risk-averse investors.
However, the situation has changed. The ETF experienced an unusually high number of 71 million daily trades on Tuesday. Furthermore, the price of the ETF has dropped by 3% just this week, marking a 20% decrease in the last six months and a 50% decrease since early 2020. This decline surpasses the stock market downturn following the dotcom bubble.
So, what can investors take away from this? Here are five key points to consider:
- The current bond market pattern is not a simple repetition of recent years. Short-dated yields rose as short-term bond prices fell when the US Federal Reserve began raising rates 18 months ago. However, long-term rates did not surge at that time. The recent rise in long rates suggests that there are deeper structural shifts in the supply and demand for bonds.
- The pace of bond price falls may seem startling, but the level of rates is not historically abnormal. In the 20th century, a 4.8% 10-year Treasury yield was considered normal. The yield curve is also slightly inverted, with short rates higher than longer ones.
- To understand the shifts driving the rate swing, it is crucial to look beyond economic data. Investor projections for future inflation and growth have increased, as well as concerns about America’s debt. However, market metrics of inflation expectations have not changed significantly. The mounting debt has been known for a long time.
- The recent bond falls highlight the behavior of non-American investors. Japanese investors may sell Treasuries to buy yen assets if the Bank of Japan allows its 10-year yield to rise above 1%. China is another factor affecting market sentiment, with some analysts suggesting they are reducing US Treasury purchases due to geopolitical tensions or financial strains at home. However, available data on this matter is relatively opaque.
- The ongoing uncertainty surrounding bond markets is unfavorable for the White House. Corporate treasurers have already taken steps to restructure their debt and secure low borrowing costs, but the US Treasury Secretary has not been able to do the same. This could lead to a significant increase in debt servicing costs.
Some investors speculate that the fiscal squeeze could prompt the Federal Reserve to cut short-term rates, while others believe the Fed will intervene to prevent potential losses in bank and insurance portfolios. If the Fed does lower rates, leveraged investors like hedge funds may start buying long-term Treasuries again. However, cutting rates may be unlikely if inflation remains above 3%, and higher long rates may be necessary to attract investors with the wave of debt issuance on the horizon.
In conclusion, investors holding the seemingly boring long-bond ETF might face more uncertainty and volatility. Exiting quantitative easing is proving to be a challenging endeavor, and the real test has yet to fully manifest.
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