Long-term Treasury bonds have had a capricious last several years, but recent market conditions are sparking renewed interest in the long bond. given a probable forthcoming rate cut cycle and the potential for lower levels of inflation, there is good reason to expect Treasuries to perform well in the coming months and quarters, as should the iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT).
Long-term Treasury bonds offer several potential advantages. They provide a steady stream of income through their interest payments, and they cannot be called back like many other bonds and CDs. They are also among the safest and highest rated of securities any market offers, as they are guaranteed by the U.S. government, and backed by its ability to tax and print dollars. Alternatively, most investments are not even permitted to include such a guarantee.
Bonds can also balance the risk of equity investments in a portfolio. This hedging capacity has not been exceedingly evident of the last few years as interest rates climbed and bonds lost value. Now, though, bonds offer a more reasonable interest rate, plus the potential to increase in value if rates should decline.
Over the last several years, the Federal Reserve aggressively raised interest rates to combat inflation. This pushed up yields on Treasury bonds, making them a better provider of income. This also reduced the valuation of existing fixed income assets like Treasuries.
That decline in Treasury bond values hurt banks and even contributed to the failure of some banks. This was and continues to be a major concern for the federal reserve, which is now fully aware that higher rates could lead to further bank failures. A similar issue has also caused a chill in certain real estate markets and the derivative mortgage businesses that serve them.
Beyond the apparent need for interest rate relief, there are other reasons to anticipate future Treasury strength. Global economic conditions are uncertain, and issues run deeper than concerns about recession and inflation, such as geopolitical tensions and outright conflict. In such environments, investors often seek the safety and stability of Treasury bonds.
The market recently repriced the probability of a forthcoming rate cut cycle. The market has presumed since last year that some level of rate cuts were likely in 2024, with some even expecting the Federal Reserve to cut rates in the first half of this year. That was clearly not the case, but the probability of the cycle to start has increased with each passing month. Now, most market pundits seem to anticipate a rate cut in September, with the strong potential for more to follow in the year’s fourth quarter.
As a result of this, Treasury bonds have approached their highest valuation in months. Moreover, the recent repricing has been fairly aggressive, with valuations essentially spiking. Some of this recent spike was likely accentuated by the volatility spike and equity decline that occurred at the start of August, but these types of risks are reasons to consider bond hedging and portfolio rebalancing.
The daily TLT chart shows a well rounded bottoming pattern so far in 2024. First, as rate cuts did not materialize along with some early anticipation, TLT and Treasuries declined in value. Nonetheless, valuations remained above their 2023 lows and formed a strong level of support in the low $90s. More recently, TLT has spiked from that low $90s level and nearly hit $100 before fading back to the mid $90s.
This recent move also takes TLT’s valuation back to a level that has acted as both resistance and support. It bounced off this level in late 2023, so there is some reason to anticipate the same could occur again here. Alternatively, with the probability of rate cuts being so high here, it seems likely that TLT can make it through this level even in advance of the Federal Reserve starting a rate cut cycle.
Risks
While long-term Treasuries present opportunities, they also come with some risks. The primary risk is interest rate risk. If interest rates rise, the price of existing bonds falls. This risk is greatest for long-term bonds, due to their duration. In essence, the change in rates is multiplied by the bond’s time until maturity.
Another risk to long-term bonds is the opportunity cost associated with making what is often considered a risk off investment. Locking money into a long-term bond could mean sacrificing potential returns from other investments.
Conclusion
TLT appears likely to continue breaking out and soon make it through the $100 level. After doing so, it also seems likely that this level will act as support, much as it did in the first half of 2023. Further, TLT is likely to continue to appreciate in late 2024 and into 2025 as the Federal Reserve cuts rates. I anticipate TLT will break through $100 in advance of the start of the forthcoming rate cut cycle. Though it may subsequently check back to this level, and this is especially likely around the election, prices should continue to appreciate along with highly probable successive rate cuts.
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