Understanding the bond market rout of the past several days, and grasping why it isn’t really a rout at all is something of an exercise in remembering to see more of the forest and fewer of the trees.
Still, noticing the trees has its place. So let’s work our way from a survey of trees and pull back for a wider-angle view of the macroeconomy through the lens of Treasury yields and the yield curve. The point will be this: The economy is on the mend and yields are grinding higher, but the recovery from the worst global economic crisis since the Great Depression isn’t over yet.
That said, the move in the past several days that lifted yields on 10-year Treasury notes to a five-month high was absolutely necessary, as a story this week in the Financial Times so aptly put it. While there are plenty of reasons for yields to still be low, the U.S. economy is recovering from the crash six years ago, and that means it’s impossible for bond yields to stay as low as they’ve been for too much longer.
And importantly, because prices of existing bonds move in the opposite direction as yields, investors are facing the prospect of capital losses. This move has lifted benchmark yields up to 2.30 percent from a 2015 low of 1.67 percent on Jan. 30.
ETF Pain, ETF Gain
A chart of 10-year Treasury yields over the past month captures the entirety of the recent move that has created so much anxiety. Yields on the benchmark note are the black line. Prices of the iShares 7-10 Year Treasury Bond ETF (IEF | A-51) in blue and the iShares 20+ Year Treasury Bond ETF (TLT | A-85) in red are both down in the past month, as prices and yields move in opposite directions.
Before running for the hills or for the safety of cash, take a look at the green line. Those are the returns of the ProShares UltraShort 20+ Year Treasury ETF (TBT). That’s a highly liquid double-inverse ETF with $3 billion in assets that’s designed to climb in price when long bonds are selling off. TBT, as its name suggests, is organized around the same index as TLT, the long-dated Treasury ETF noted above.
In the three months that TLT has lost more than 7 percent, TBT jumped about 15 percent.
If that sounds too good to be true, it just might be. TBT, because the portfolio is rebalanced daily, only truly works when markets are clearly trending. That’s the past half-month in a nutshell, which is great for holders of TBT. But markets aren’t always so cooperative, which is why TBT is really only for folks, like hedge fund managers, who understand you shouldn’t hold onto it for too long.
A Longer Look-Back
Apart from the virtues of an ETF like TBT that can be godsend in a bond market sell-off, it’s worth pulling back and looking at Treasury yields over the longer term. The chart below shows 10-year Treasurys dating back to May 2013, when the so-called taper tantrum gripped financial markets, convinced bond prices would collapse as the Federal Reserve ended quantitative easing (QE).
Note that the peak in yields at the beginning of 2014 when the taper tantrum had run its course was at 3.00 percent—quite a bit higher than the 2.30 percent level at the end of the most recent upward move. Crucially, the current market doesn’t seem to be in the grips of another taper tantrum, and with good reason. After all, central banks in Europe and Japan are now in full QE mode.