Belly Of T-Curve Moves Most With Fed

July 05, 2013

Through the pain of potential capital losses, the world of Treasurys ETFs is telling the tale of a recovery that’s starting to bloom.

Prices and yields of U.S. Treasurys ETFs have been moving quite a lot in the nearly two months since the Fed began signaling that the end to the post-crash period of easy money may start to take shape this year, but nowhere has the movement been more pronounced than in the middle of the yield curve.

The benchmark 10-year Treasury note moved to a two-year high of 2.73 percent on Friday morning after the U.S. government reported that the economy generated more jobs than expected in June, in the latest sign that the Fed may truly begin “tapering” the quantitative easing that it has had in place since the crash of 2008-2009.

“This reversion to the mean is basically at the middle part of the yield curve. Long rates haven’t increased that dramatically, and short-term rates haven’t budged at all,” William Bernstein, the author of investment books and a well-known figure in passive investment circles, said.

In any case, the implications of an improving economy and a Federal Reserve that is on the verge of tightening its five-year ultra-loose monetary policy is clear—T-bills will be safe from capital losses, but the longer the duration of a given bond security, the more its price will be affected by any change in the interest-rate outlook.

Prices Across The Breakdown In The ETF Market

The iShares Barclays 10-20 Year Treasury Bond Fund (NYSEArca: TLH), a fund that holds some 10-year paper, has slid 5.36 percent since the start of the year, and since the end of April, just before yields started their recent upward trend, the $354 million fund has suffered redemptions of $274 million.

The long-dated $4.1 billion iShares Barclays 20+ Year Treasury Bond Fund (NYSEArca: TLT) has taken the biggest beating, falling 8 percent since the start of the year. Interestingly, TLT has had inflows of $622 million since Ben Bernanke’s tapering talk took the markets by storm—a possible sign of a deep-pocketed player creating TLT shares for the express purpose of loaning them out to short-sellers.

The $4.5 billion iShares Barclays 3-7 Year Treasury Bond Fund (NYSEArca: IEI), a fund that has served in the past several months as a canary in the coal mine in connection with Fed-watching guesswork, has dropped 1.79 percent, while garnering inflows of $2.4 billion since the end of April—a sign investors are moving to shorter duration even as the fund suffers some capital losses.

Finally, the short end of the curve—including funds like the iShares Barclays 1-3 Year Treasury Bond Fund (NYSEArca: SHY) and the SPDR Barclays 1-3 Month T-Bill ETF (NYSEArca: BIL)—have barely budged at all in price this year.

The fact that SHY has $8.4 billion in assets and just $817 million in inflows since early May suggests that many in the market have been playing defense on the short end of the Treasurys market for quite some time.

Bond Performance: 12-31-12 to 7-3-13


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