The iShares 20+ Year Treasury Bond ETF (TLT) ETF, which tracks the ICE U.S. Treasury 20+ Year Bond Index, is down by about 10.63% from its 52-week high reached of 128.35 reached on Dec. 15, 2017. The US Treasuries have had a horrible year due to a hawkish Fed that has raised rates three times this year already. However, the ETF has risen by about 2.11% since the beginning of this month due to anticipation of a more dovish Fed.
Note that Treasury bond prices and the yields they offer are inversely correlated. As yields rise, the value of Treasuries fall. Yields are strongly driven by monetary policy from the central bank. Therefore, the recent dovish Fed causes yields to fall and Treasury prices to increase, consequently pulling the TLT ETF higher as well. Now the question is whether this is a good time to buy into the ETF.
It is worth noting that longer-term bonds are more price sensitive to interest rate movements and guidance from the Fed. Long- term bonds such as 30-year treasuries are considered more riskier than short-term treasuries like the 3-year note, because there is a greater probability that interest rates will rise (and drag bond prices lower) within a longer time period than within a shorter period. Shorter periods of time are hence less predictable and more riskier than longer periods of time. The TLT ETF tracks treasuries that have maturities of more than 20 years, hence long-term bonds. While these are more riskier, their price sensitivity means the bonds also produce greater returns during lower interest rate cycles.
Source: Yahoo Finance
The investment seeks to track the investment results of the ICE U.S. Treasury 20+ Year Bond Index (the “underlying index”). The fund generally invests at least 90% of its assets in the bonds of the underlying index and at least 95% of its assets in U.S. government bonds. The underlying index measures the performance of public obligations of the U.S. Treasury that have a remaining maturity greater than twenty years. The fund has an expense ratio of 0.15%.
The Top 10 holdings of the ETF include:
Risk Note: The Fund may be subject to tracking error, which is the divergence of the Fund’s performance from that of the Underlying Index. Tracking error may occur because of differences between the securities held in the Fund’s portfolio and those included in the Underlying Index, pricing differences, differences in transaction costs, or the Fund’s holding of un-invested cash.
On Nov. 14, 2018, inflation data for October was released, which showed that inflation increased by 2.5% YoY during the month. The number matched market expectations and was higher than the previous month’s rate of 2.3%. This inflation rate is above the Fed’s 2% target, which allows the Fed to be more hawkish. However, it is worth noting that the price of oil was higher during October than it is now, which supported inflation higher. Given the recent bearish sentiment in the oil market (due to a global economic slowdown), oil is not expected to be a boost to inflation in the near future.
Moreover, the October core inflation rate, which is the rate excluding food & energy prices, came in at 2.1%, and missed the 2.2% forecast, and is also lower than previous month’s rate of 2.2%. I believe that slower core inflation and weaker outlook for the oil price will encourage the Fed to be less hawkish, which would result in treasury yields falling and the TLT ETF rising.
Fed acknowledges headwinds
Fed chairman Jerome Powell also acknowledged last week that the US economy could face some headwinds going forward. These included slowing global growth/ demand and the lagging effect of past rate hikes on the US economy. The fact that the Fed chairman is highlighting these issues signals to me that the Fed may become more bearish as we approach the December meeting. This is certainly a change of tone from his statement made on Oct. 3 that rates were “far from neutral”.
As a result, while the Fed is still expected to hike rates in December, I believe Powell may bring up these issues again during the Fed press conference on Dec. 19, in order to assure the markets that the Fed is certainly taking potential headwinds into consideration. Therefore, any potential dovish Fed communication will definitely cause treasury yields to fall and bond prices to rise. Therefore anyone considering gaining exposure to the treasury market should consider buying the TLT ETF now.
Fed Vice chairman Richard Clarida also expressed dovishness last week, stating, “global growth is cooling”. Moreover, he also stated that the fact that short-term borrowing rates are currently at neutral “makes sense”. This gives a strong indication that he feels that the Fed has hiked enough and that there is a strong possibility that the Fed may pause its rate hikes in 2019. Hence, given that the top two officials at the Fed are expressing caution over the economy, increased Fed dovishness could certainly support the TLT ETF higher.
While the Fed could remain on its path for raising interest rates in the near future, markets tend to price in future actions. If Fed is more bearish in the December press conference, the market could price in fewer rate hikes going forward. Keep in mind that Fed communication on monetary policy guidance is a key driver of US Treasuries. Hence given the increased likelihood of dovish guidance from the Fed in December, this may be a good time to buy into the TLT ETF following the 10.63% decline over the past year.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in TLT over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.