4 Charts To Help Bond Investors Sleep Well

Yes, bond yields are ticking higher these days, but it’s important to keep the whole yield-curve picture in mind.

Managing Editor
Reviewed by: Olly Ludwig
Edited by: Olly Ludwig

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.

Lessons In The Yield Curve

Taking a step further that this notion there’s really nothing for bond investors to be panicking about right now, let’s look at the yield curve more closely.

In the first chart below, the darker red line above is the U.S. Treasurys yield curve on March 9, 2009—the day of the market low after the subprime mortgage crisis had obliterated half of the S&P 500 Index’s value. The lighter red line below is the yield curve last Friday, May 8—the day that the U.S. government reported a solid-enough monthly jobs report to persuade investors that the recovery was back on track after a winter lull.

To make it plain: the yield curve is currently below where it was the day of the market nadir. So what does this mean?

Analysts like Shehriyar Antia, who contributes to ETF.com’s “Alpha Think Tank,” say the current yield curve reflects heavy QE involvement of central banks around the world. The yield curve late in the winter of 2009 actually reflected underlying fundamentals more faithfully than it does now, Antia says.

Translation: The global economy may be stabilizing, but it’s still on life support and probably needs to be. All of this points to reasons bond investors don’t need to head for the exits quite yet. Some advisors, such as John Forlines III, the head of JAForlines Global, starting buying "duration" during the recent bond market sell-off, seeing a modest value play in the goings on.

Buyers Beware

Perhaps another comparison of the yield curve at two distinct moments in time will help dispel notions that maybe I’m building some blindly bullish bond argument.

In the chart below, the line in lighter red, like in the chart above, reflects the Treasurys yield curve last Friday. The darker one below is from Jan. 30, 2015—the year-to-date low for benchmark 10-year Treasury yields of 1.67 percent.

Charts courtesy of StockCharts.com

This chart tells the tale of normalization—that yields across the curve are indeed grinding higher, as they should be, if the Fed is to raise official short-term interest rates, probably sometime later this year.

The takeaways: Yields have recently been moving higher because the economy is, again, slowly recovering. But, again, that does not mean the bond market is about to fall apart.

At the time this article was written, the author held no positions in the securities mentioned. Contact Olly Ludwig at [email protected] or follow him on Twitter @OllyLudwig.

Olly Ludwig is the former managing editor of etf.com. Previously, he was a financial advisor at Morgan Stanley Smith Barney and an editor at Bloomberg News. Before that, Ludwig was a journalist at the Reuters News Agency in New York.