TLT, Bond ETFs Hit by Surging Rates

Bond ETFs hit their lowest levels of the year as interest rates surged on Thursday. The benchmark U.S. 10-year Treasury note yield jumped as high as 4.47%, reaching its loftiest level since 2007.  

The yield on the five-year Treasury note also hit a 16-year high at 4.65% on Thursday, while the yield on the 30-year Treasury bond climbed to a 12-year high at 4.57%.  

As yields spiraled higher, bond ETFs that track Treasuries slid (bond prices and yields move inversely). 

The iShares 20+ Year Treasury Bond ETF (TLT)—this year’s third most popular ETF by inflows—is now down nearly 6.6% year to date.  

The iShares 7-10 Year Treasury Bond ETF (IEF) also hit a new low for the year and is now down by 2%.  

Higher for Longer Hits Bond ETFs 

The recent upside acceleration in market-based interest rates comes on the heels of the Federeal Reserve's decisions to hold rates steady while suggesting that another rate hike could be in the cards later this year.  

Probabilities based on the pricing of fed funds futures suggest there is a 40% chance that the Fed hikes rates again sometime this year.  

But it’s not the potential for another rate hike that’s weighing on the bond market. It’s the idea that the Fed will hold rates at or near peak levels for longer than previously expected. 

In its latest Summary of Economic Projections, the central bank indicated that the fed-funds rate could end 2024 at 5.1%—about half a percent higher than it had projected in the June SEP.  

If the fed-funds rate stays above 5% for a year or longer as the Fed is currently anticipating, then that will have an upward pull on all interest rates.  

After all, the yield curve is still inverted; the 10-year Treasury yield is around 90 basis points below the fed-funds rate.  

If investors start to believe the Fed might hold the fed-funds rate at its peak level for a while, it makes sense for them to start pricing that into longer-term interest rates.  

This “higher-for-longer” idea is one espoused by the Fed itself, but it’s been buttressed by recent strong economic data.  

A model from the Federal Reserve Bank of Atlanta estimates that U.S. gross domestic product in the third quarter could be growing at a 4.9% annualized rate—well above what the Fed or most economists have been expecting.  

Such strong growth is welcome on the one hand, but it also introduces the risk of inflation picking up again.  

To push back against that risk, the Fed is likely to maintain a hawkish bias in its monetary policy.  

Bond ETFs Getting Hit  

Treasury bond ETFs aren’t the only funds getting hit by the “higher for longer” narrative. The iShares iBoxx $ Inv Grade Corporate Bond ETF (LQD) has nearly wiped out all of its gains for the year.  

The two biggest bond ETFs, the iShares Core US Aggregate Bond ETF (AGG) and the Vanguard Total Bond Market Index Fund ETF (BND) have also given up their gains.  

AGG and BND hold a combination of various types of investment-grade bonds, including Treasuries, mortgage-backed securities and corporate bonds.  

One bond ETF that is holding up better than others is the iShares iBoxx $ High Yield Corporate Bond ETF (HYG). The junk bond fund is still sporting a gain of more than 4.6% for the year.  

Stronger economic growth means the issuers of high-yield bonds are less likely to default, which is good news for the holders of those bonds.  

Still, if rates keep surging, at some point that will likely weigh on junk bonds as well.