What to Do About a Treasury ETF Bubble?
December 8th 2010 at 1:00pm by Tom Lydon
For months, the markets have been buzzing about what looks like a bubble in Treasury bonds and bond exchange traded funds (ETFs).
As market volatility spiked in the first half of the year, investors took shelter in Treasury bonds, the safest type of debt around. Investors also went far out on the Treasury yield curve, because short-term Treasury bonds continue to yield less than 1%.
But that rush to long-term Treasuries hasn’t been without consequence. In exchange for that protection, investors are earning very little money. For example, the 10-year Treasury yield only recently moved back above 3%. It’s all because bond prices and yields share an inverse relationship: when bond prices rise, yields fall, and vice versa.
Check out this chart of the 10-year Treasury and you’ll quickly get a sense of how yields have been pushed lower as a result of investor buying:
There’s also a risk in holding long-term Treasuries in a strengthening economy.
The risk lies in rising interest rates. The Federal Reserve lowered them to record levels in December 2009 in hopes of stoking economic growth, but they can’t remain low forever. With quantitative easing now in play, better economic numbers and the mid-term elections past, the chances go up that the Fed will boost rates sooner rather than later. [The Allure of Bond ETFs.]
If you’re an investor sitting in long-term Treasuries, you need to be prepared to act. When the Fed raises rates, the inverse relationship will switch: prices will fall, yields will rise and your principal will be at risk.
There are two ways to play this scenario by going short on long-term Treasuries: with the ProShares UltraShort 20+ Year Treasury (NYSEArca: TBT) or the Direxion Daily 30-Year Treasury Bear 3x Shares (NYSEArca: TMV). Both have just recently crossed above their 200-day moving average on Tuesday.
Investors seem to have been feeling generally bearish on Treasuries over the last couple of months as fears that the Fed will raise rates grow. In August, for example, TBT was the fifth most popular U.S. ETF, raking in $585 million in new cash. Year-to-date through November, the fund has amassed $2.14 billion in new money while TMV has taken in $214 million in the same time frame to increase its assets nearly 175% from a year ago. [Coping with a Bond Bubble In Retirement.]
Of course, like all leveraged and inverse ETFs, TBT and TMV aren’t for everyone. Returns can diverge from the underlying index as a result of compounding, so be prepared to monitor such ETFs closely when you own them.
For full disclosure, Tom Lydon’s clients own TBT.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.