Might Bond Bear Awaken for a Quick Rumble?

September 19, 2022

“The trend is your friend,” as well as the dozen or so exceptions to that rule, including the one that says a bear market trend, is rarely a straight line. 

This is good to keep in mind while looking at the iShares 20+ Year Treasury Bond ETF (TLT), which reflects long-term U.S. interest rates and which has lost nearly a third of its value over the past two years as rates climb. 

The fund has around $25 billion in assets, trades nearly 15 million shares daily and has a 0.15% expense ratio.) 

Rates will likely keep rising for the near future, which isn’t great news for those who invest in bonds with maturities stretching into decades. Ironically, the more TLT falls, the greater the odds of a sudden and violent rally.  

The Fed’s economists have made no secret of their plans to continue to boost short-term monetary policy and quantitative tightening to push inflation to its 2% target rate, with another rate hike all but certain to come out of the Sept. 20-21 Federal Open Market Committee meeting. The only question appears to be whether or not the committee will raise by 50 basis points, 75 basis points or a full point. 

Meanwhile, the Fed doubled its quantitative tightening in September, saying it would cut $90 billion in assets from its balance sheet. The quantitative tightening has put downward pressure on longer-term bonds, fostering higher rates further along the yield curve over the past months. 

But what if the Fed tightens too fast, sparking enough economic pain that they foil expectations and hit the pause button on rate increases? Then things might get interesting for TLT. 

TLT Follows Long Bond Futures 

The U.S. 30-year Treasury bond futures have made lower highs and lower lows since 2020.  

 

Source: Barchart 

 

The chart highlights the bearish trajectory of the long bond futures contract. 

 

Source: Barchart 

 

Meanwhile, TLT has obediently followed the long bond futures contract since 2020.  

Next Target: 2013 Low 

The most recent low in the long bond futures was at the 132-04 level in June 2022, the lowest level since April 2014. The futures were close to the June low at the 132-31 level on Sept. 12. 

 

Source: Barchart 

 

TLT in June hit an eight-year low of $108.11. This month, it made a lower low of $107.42. The next technical support level for TLT is at the 2013 $101.17 low; for the long bond, it stands at the 2013 127-23 bottom.  

Is TLT a Stealth Buy? 

While the long-term U.S. interest rates trend remains higher, many commodity prices have retreated over the past months, which will likely begin to push the consumer and producer prices down.  

Moreover, while a recession hasn’t been declared, the U.S. economy experienced back-to-back quarterly contractions, a traditional definition of a recession. Raising interest rates during an emerging recession may worsen things. Hawkish monetary policy means the central bank has chosen an inflation battle at the expense of a recession.  

Throughout most of 2021, the central bank and the Biden administration downplayed rising inflationary pressures, calling them a “transitory” and pandemic-related event. When consumer price index and producer price index data continued climbing to the highest levels in over four decades, the central bank decided the economic conditions were far more than “transitory” and hit the tightening panic button.  

This year the Fed and administration have called the back-to-back contractions an economic “transition,” not a recession. Time will tell if they are making a similar mistake, and rate hikes will only increase the severity of any “transitions.”  

Bonds market and TLT are in bear markets, where every rally has been a selling opportunity since 2020. However, even the most aggressive bear market can experience “rip your face off” rallies that shake the confidence of even the most committed bears. The bond futures rallied from the June 132-04 low to 145-31 in August and TLT from $108.11 to $120.69 per share over the same period. While they are back at the lows, the odds of future corrections rise with each new multiyear low.  

The bear continues to stalk the U.S. bond market as the Fed battles inflation. TLT looks set to challenge the 2013 low over the coming weeks and months. However, it will not likely be a straight line lower, as “transition” sounds a lot like “transitory.”  

Any change in the central bank’s monetary policy plans could shock the bond market and cause sudden and violent rallies. The lower the bonds fall, the more attractive a short-term long position becomes, as a significant move could run counter to the current established trend.

Here’s the kicker: Another quarterly decline in GDP could cause the Fed to pause its aggressive monetary tightening as the odds of a recession increase. A pivot by the central bank would likely ignite a recovery rally in the bond market and TLT. 

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