TLT Price Rises With Fed Rate Cut Expectations

Bond ETF prices are on the rise again, as this week’s economic data all but guarantees that the Federal Reserve will reduce its key interest rate when it meets next month. 

The iShares 20+ Year Treasury Bond ETF (TLT) has risen 2.5% in the past five trading days as the Fed Funds futures market now predicts a 100% chance of a September rate cut, with the odds split nearly evenly between a 25- and a 50-basis point cut. 

The bond market proxy’s price increase reflects the softer data reported in this week’s Producer Price Index and Consumer Price Index.  

The PPI edged up 0.1% month-over-month in July, less than the +0.2% expected and cooling from the 0.2% increase in June, according to the U.S. Department of Labor. 

The CPI edged up 0.2% last month, matching the 0.2% increase expected, while the year-over-year increase of 2.9% was under the 3.0% expected, according to data released by the Bureau of Labor Statistics on Wednesday. 

The yearly increase in inflation marks the smallest rise since March 2021, as the soft-landing narrative remains fully supported and the recession panic that arose in the week prior fades further. 

How TLT, Bond ETFs Price in Fed Rate Cuts 

The bond market is often referred to as a forward-looking mechanism for interest rates because it reflects market participants' expectations about future economic conditions and monetary policy. Long-term bonds are more sensitive to interest rates, which makes bond ETFs like TLT more attractive to investors seeking higher price gain potential. 

As investors anticipate lower interest rates in the future, the value of long-term bonds (which TLT tracks) becomes more attractive. This is because newly issued bonds will offer lower yields, making older, higher-yielding bonds more desirable. 

Here's a breakdown of how TLT and other bond ETFs price in Fed rate cuts: 

• Watching the Fed: The bond market is highly sensitive to central bank actions and statements. Any hints about future monetary policy changes can significantly impact bond prices and yields.  
• Market sentiment: Bond prices move inversely to interest rates. When investors anticipate rising interest rates, they sell bonds, pushing prices down and yields up. Conversely, if investors believe rates will decline, they buy bonds, driving prices up and yields down. This reflects market sentiment about future economic conditions and monetary policy.    
• Inflation expectations: Bond yields incorporate inflation expectations. If investors anticipate higher inflation, they demand higher yields to compensate for the erosion of purchasing power. This can influence the shape of the yield curve and overall bond prices.  

When the Fed cuts rates, the market has already priced in the decision. This is why bond investors, especially the traders attempting to capitalize on the Fed’s rate policy decisions, follow economic data so closely: they watch the same data that the Fed monitors so that they can capture the price gain ahead of the move.