Until recently, the so-called “$TLT” exchange-traded funds (which track long-term Treasury bonds) seemed dull as ditch water. Historically, price movements have been small and trading volumes have been low, making it suitable for widows and orphans—in other words, risk-averse investors.
not now. On Tuesday, the ETF’s daily trading volume was 71 million, many times higher than usual.and price Down 3% this week alone, it is now down 20% over the past six months and down 50% since the start of 2020. That’s even more than the stock market crash that followed the dot-com bubble.
What conclusion should injured investors draw? There are five key points to understand. First, the current bond market landscape is not – repeat, no – This is just a repeat of what we have seen in recent years. When the Fed began raising interest rates 18 months ago, short-term yields rose as short-term bond prices fell (the two tended to move in opposite directions.)
However, long-term interest rates have not surged, apparently because investors believe inflation and growth will eventually decline.
This year, however, while short-term rates have stabilized (seemingly as central bank tightening comes to an end), long-term rates have risen sharply. This suggests that long-term rates are changing due to deeper structural changes in bond supply and demand; therefore, this is “not just” about the Fed.
The second key point is that while the pace of declines in bond prices is alarming by historical standards, the level of real interest rates is not. By contrast, for much of the 20th century, a 10-year Treasury yield of 4.8% was considered normal, if not benign.
So from a long-term perspective, the strangest thing today is not that yields are rising, but that yields have been so low over the past decade. Even stranger, the yield curve is still slightly inverted (i.e., short-term rates are higher than long-term rates.)
Third, if you want to understand the structural changes driving interest rate movements, don’t just look at economic data. Yes, investors have recently raised their forecasts for future inflation and growth. Yes, there are growing concerns about U.S. debt, which has doubled since 2011 to $33 trillion due to political gridlock.
But market indicators of inflation expectations have actually not changed recently. This debt has been there for a long time. Hence the congressional drama.
So this leads to the fourth key point: The recent bond decline has put the behavior of non-U.S. investors into the spotlight.
One factor influencing market sentiment appears to be concern that if the Bank of Japan lets the 10-year bond yield rise above 1%, Japanese investors may sell U.S. Treasuries and buy yen assets.
The other is China. Some analysts, such as Apollo’s Torsten Slok, believe China is reducing its purchases of U.S. Treasuries, either due to geopolitical tensions or domestic financial jitters.besides Fortune International Capital (“TIC”) data Seemingly supporting this: China’s stock holdings fell from $939 billion to $821 billion over the past year.
But Brad Setser of the Council on Foreign Relations think this The TIC series is misleading: China not only buys US agency bonds, but also buys US assets through European entities such as Euroclear, which are excluded. If that is included, he believes “China’s reported U.S. asset holdings look largely stable between $1.8 trillion and $1.9 trillion.”
Regardless, the bottom line is that no one knows for sure because the data is so opaque.
Today’s markets thus echo the risk pattern of 2007: a highly interconnected system highly exposed to developments in a dark, little-known corner of finance—but the problem isn’t subprime mortgages, it’s Beijing’s take on Treasuries appetite.
The fifth point is that amid this uncertainty, at least one thing is crystal clear: What’s happening is bad news for the White House.
Savvy corporate treasurers are already scrambling to restructure debt to lock in the low borrowing costs of the past decade for as long as possible. But U.S. Treasury Secretary Janet Yellen has failed to do that. That means debt service costs will soon balloon; in fact, they’ve already done so, sparking talk of bond “vigilantes.”
Some investors believe (or pray) that this fiscal tightening will prompt the Fed to lower short-term interest rates.
Others believe the Fed will be forced to take action to prevent a repeat of the Silicon Valley Bank meltdown this spring, when tumbling bond prices once again inflicted losses on bank and insurance portfolios.
If the Fed does cut short-term interest rates significantly, it could persuade leveraged investors such as hedge funds to start buying long-term Treasuries again.
However, as a bond master Bill Gross pointed out, If inflation remains above 3%, it is difficult to imagine the Fed cutting interest rates. In this case, given the looming wave of debt issuance, long-term interest rates will need to rise even higher – say above 5% – to attract investors.
So the bottom line is that those holding this less boring long-term bond ETF could be in for a lot more drama. But no one said then that exiting QE would be easy; the real challenge was just beginning.
gillian.tett@ft.com
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