Rates are back on the rise. Following what was interpreted as a dovish FOMC press conference by Jay Powell last week, a hot jobs report (along with spicy JOLTS and claims data) has reset traders’ expectations for where the Fed’s terminal rate will land.
At more than 5.1% now, and with a pronounced “higher for longer” narrative unfolding, Treasurys both on the short-end and long-end of the curve have come under pressure. The 2-year is near 4.45%, 10-year 3.7%, while the 30-year is 3.65%.
I expect rates to stabilize about where they are. My logic on that is the fact that stocks have generally held up well as rates have crept back up. What’s more, Treasury rate volatility, as measured through the MOVE Index, is near 6-month lows.
It appears the massive swings (and upward moves in yields) seen in 2022 may not continue this year. That’s how I view the fundamentals. With longer-term inflation expectations also in check, I see the 30-year in the 3.5% to 4% range as fair.
Rate Volatility Falling
Your view on where the long bond will go can be expressed by trading a number of products. An aggressive way to do it is through leveraged short plays. One ETF is the go-to.
According to the fund website, the ProShares UltraShort 20+ Year Treasury ETF (NYSEARCA:TBT) seeks daily investment results, before fees and expenses, that correspond to two times the inverse (-2x) of the daily performance of the ICE U.S. Treasury 20+ Year Bond Index.
TBT is a useful product to profit from a decline in the price of long-dated Treasurys and it can serve as a hedging tool against a long portfolio of bonds if you have a very short-term bearish outlook on the long-end of the Treasury yield curve.
TBT launched in 2008 and it trades with a high expense ratio of 0.89%. With net assets of more than $800 million and a median 30-day bid/ask spread of just four basis points, the cost is elevated but tradeability and liquidity are strong. Investors looking to place leveraged bets on the Treasury market can also simply short long ETFs or trade options on bond ETFs which are also sometimes quite liquid.
Of course, with a leveraged short ETF, it’s key to understand the mathematical impact of volatility on return should you hold something like TBT beyond a few days. While a straight-line move higher in the 30-year yield (a selloff in the long bond) would result in strong returns to the TBT holders, whippy price action in TLT would result in a slow decay of TBT’s NAV and market price.
You’ll find that TBT’s portfolio is long Treasury bonds maturing primarily in 2048 and later. So, interest rate risk is very high while default risk is effectively zero with the holdings. ProShares uses Treasury index swaps to establish a net short position. The index’s modified duration is 17.4 years with a weighted-average maturity near 26 years. The weighted-average coupon is 2.5% with a weighted average yield to maturity of 4.07%, according to ProShares.
TBT: Long Treasurys, Short Swaps
The Technical Take
With my neutral stance on where TYX will head, let’s see what price action suggests. Notice in the chart below that TLT (which I will use to determine a price outlook on TBT) has clear resistance in the $109 to $110 zone. A rally above that would send yields lower and TBT down. So, if you are long TBT, you want to see TLT not rise above this resistance level.
There is also an uptrend support line in play off the October low – that forms a bearish ascending triangle since the trend of larger degree is down – this favors a long TBT play so long as TLT is under $110. What’s more, I see momentum waning as time progresses in this TLT advance, supporting the case that TLT could break lower. A long TBT position with a stop corresponding to a rally above $110 on TLT makes sense.
Look to TLT for Clues on Where TBT Goes: $110 Key
The Bottom Line
I like TBT for a trade here, though I would take profits on a gain of 10% to 20% since my longer-term stance is neutral on the 30yr yield. Also, TBT should not be owned for an extended period due to negative compounding return risk.
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