This Treasury Bond ETF Trade Is Hot Again

Buying long-dated U.S. Treasury ETFs was a pretty unpopular idea late last year. That tide now seems to be turning.

You could say a lot has changed in a few short months. Last fall, investors were faced with the end of the 30-year bond rally, and interest rates were expected to rise again putting pressure on the value of bonds. More importantly, a new U.S. administration was coming in, with the promise of pursuing domestic growth policies that would fuel a stock market rally. It was all about risk-on.

A fund like the iShares 20+ Year Treasury Bond ETF (TLT) bled more than $850 million to net redemptions in less than two months following November’s presidential election. As money was coming out of the fund, TLT was dropping—to the tune of some 8.3% in losses in that same period.

Here’s a look at the performance of TLT in the past year (relative to the S&P 500)—note the plunge following the U.S. presidential election in November. There was a huge divergence in direction:

Coming into 2017, speculators mounted a short position in U.S. Treasury futures that a hit a “historic high” in the first quarter of this year, according to DoubleLine’s latest quarterly report. By mid-March, 10-year Treasury yields closed at a high of 2.61%—its highest closing level since September 2014.

And now, a month later, yields on 10-year Treasuries are testing the 2.2% level, down more than 40 basis points from their March high (bond yields fall when prices rise). TLT has seen net creations of more than $700 million year-to-date, half of which has come in the last month alone as the fund rallied some 5.5%. Year-to-date, TLT now has gains of about 4.1%. 

Charts courtesy of StockCharts.com

What’s Happening 

The risk-off trade is popular again.

Here’s why: That euphoria over the prospects for regulatory reform and U.S. growth is now being discounted by the market. Confidence in the government’s ability to actually implement reform and effect change is fading ever since the administration failed to revamp health care regulation. That has contributed to a weakened dollar.

Mounting geopolitical risks is another key driver of demand for long-dated Treasuries. President Trump’s growing focus on foreign policy, and his recent actions with regard to Syria and North Korea, have investors increasingly on edge.

Guggenheim’s CIO Scott Minerd said Monday the drop in yields and rising demand for bonds result from “[Washington] D.C.’s struggle to pass pro-growth policies and rising geopolitical/military risks.”

Massive Short Bet Unwinding

According to Minerd, we could see 10-year Treasury yields drop to 1.5% “or lower” by this summer if this trend stays in place. That would amount to a 32% decline in rates from current levels, and the lowest yields we’ve seen since last summer.

Minerd isn’t alone. DoubleLine’s Jeffrey Gundlach had been calling for a drop in yields, and a test of the 2.2% level, since earlier this year. The unwinding of that massive short position has something to do with it.

“With investors piling on to a one-sided trade, an unwinding of these positions could only add to demand,” reads DoubleLine’s most recent report. “As investors began to take down short positions through March, we have also kept an eye on inflation as it appears to be peaking out over the month of April especially as the base effects from energy begin to roll off.”

Inflation Peaking

The firm’s prediction includes inflation, as measured by the Consumer Price Index, peaking around 2.9% before turning lower into the summer months, “a move that could also be supportive of lower rates over the near term.”

What could push yields higher instead? A rate hike in June, if it’s accompanied by strong GDP data, DoubleLine said. The Federal Reserve raised rates again in March, and the market expects at least two more rate hikes this year. It remains to be seen whether June will bring one of them—the market is currently pricing a 50% chance.

TLT tracks a market-weighted index of U.S. Treasury bonds with remaining maturities of 20 years or more. The longer-dated the bond is, the more sensitive it is to interest rate hikes. TLT has effective duration of about 17.5 years.

The ETF has $6.1 billion in assets, and is the biggest and most liquid long-term U.S. Treasury fund on the market.

Contact Cinthia Murphy at [email protected]