In September, the Federal Reserve announced a 50 basis point rate cut, marking a shift into an easing cycle. However, the bond market performance caught many investors off guard.
Before the September policy meeting, the 10-year U.S. Treasury yield briefly dipped to 3.6%. After the rate cut was implemented, yields surged significantly, surpassing 4.3% by October 29.
Since bond prices and yields move inversely, products tracking U.S. Treasuries have recently seen notable pullbacks, causing distress for investors who bet on declining rates.
U.S. Treasuries are widely regarded as one of the safest investment tools globally due to their liquidity and relatively low volatility, but this perception is now being challenged.
According to The Financial Times, $iShares 20+ Year Treasury Bond ETF (TLT.US)$ is becoming the new "Widow Maker", a term typically used to describe consistently underperforming investments. Since mid-September, TLT has dropped nearly 9%, erasing all gains made earlier in the year.
Source: Financial Times. This is for information and illustrative purposes only. It should not be relied on as advice or recommendation.
Despite the setback, substantial capital remains optimistic. The ETF Database reports that nearly $1 billion flowed into TLT during last month's decline, contributing to over $17 billion in net inflows over the past year.
Typically, when the Federal Reserve lowers policy rates, bond yields decrease, resulting in strong performances in the bond market. However, what explains the unusual behavior in the current bond market, and what does the future hold?
Pricing in a "no landing" scenario?
A few months ago, the market focus was whether the U.S. economy could achieve a soft landing (a moderate growth slowdown without a recession) or a hard landing, characterized by a severe economic downturn. Both scenarios theoretically lead to declining bond yields.
However, recent positive employment and inflation data have fueled expectations of a "no landing" scenario.
In early October, U.S. non-farm payroll employment increased by 254,000, far exceeding the expected 150,000. Subsequent unemployment, CPI, and retail sales data also surpassed market expectations.
In a "no landing" scenario, sustained economic growth and persistent inflation could limit the Fed's ability to cut rates further.
A Bank of America survey indicated that the chance of a "no landing" has risen from 7% last month to 14%.
Former U.S. Treasury Secretary Larry Summers said the Fed's 50 basis point cut was "a mistake," underestimating the complexities of disinflation. Hedge fund manager Stanley Druckenmiller, once George Soros's aide, said he began to short Treasuries following the cut.
This is for information and illustrative purposes only. It should not be relied on as advice or recommendation.
Additionally, the upcoming elections could be an important factor.
Bloomberg reports the rising yields also reflect growing concern that the Republican Party could take control of both the White House and Congress in the November 5 election, potentially boosting the federal deficit and inflation.
Have rates peaked?
According to Pacific Investment Management (PIMCO), there have been four instances where U.S. Treasury yields rose after rate cuts, with the current yield increase being the largest on record.
Source: PIMCO. This is for information and illustrative purposes only. Past performance does not guarantee future results.
Within a month following the latest cut, the 10-year Treasury yield rose by 38 basis points, surpassing the previous record of 32 basis points set in 1995.
The contexts of both periods share some similarities. In 1995, the Fed cut rates by 50 basis points under Alan Greenspan's leadership. And the year also saw a technological revolution driven by the Internet.
Back then, the Fed successfully cooled the economy and avoided a recession, achieving a soft landing and Treasury yields trended downwards.
PIMCO analysts suggest that if the economy mirrors 1995, core bond portfolios could still generate positive returns.
From the options market, the current rate increase might also be adequately priced. The option skew reflects market expectations of asymmetric future price volatility for target assets and it serves as an indicator of investor sentiment and future expectations.
The negative skew in bond options (where the implied volatility of low-strike price options exceeds that of high-strikes) indicates a pessimistic market outlook. The put/call skew for Treasury futures reached last year's low, when the 10-year Treasury yield briefly surged above 5%.
This is for information and illustrative purposes only. It should not be relied on as advice or recommendation.
However, some believe the rate hike is far from over. Paul Tudor Jones, who predicted the 1987 stock market crash, recently stated "All roads lead to inflation". He said both parties overlook the U.S. deficit issue, and uncontrolled government spending will lead to significant bond market sell-offs and soaring rates.
How to invest in U.S. Treasuries
U.S. Treasuries offer a wide range of durations, from as short as one month to over 30 years. Generally, longer-duration bonds are more sensitive to interest rate changes and exhibit greater price volatility.
Holding individual bonds requires more active management, so regular investors might consider using ETFs for a diversified bond portfolio.
The market offers various bond fund products with different durations. Investors can explore Treasury-tracking products in the Thematic ETF section on niuniu.
To access the feature, go to Markets> ETF> Thematic ETF> U.S. Treasury Bond ETFs.
The largest U.S. Treasury-tracking ETF by asset size is the aforementioned $iShares 20+ Year Treasury Bond ETF (TLT.US)$ , which also has the longest duration.
If you already hold Treasury-related products and remain optimistic about their long-term performances, you might consider using options to reduce costs.
A common approach is Covered Call—selling call options while holding the underlying asset. The premium collected could offset losses if prices continue to fluctuate or decline. But if the trend reverses in the future, you also risk losing the gains from the potential surge.
Options involve higher risks and volatility than stocks. Investors should study them thoroughly before participating.
Related risks
Several key macro events are on the horizon, such as the U.S. non-farm payroll this Friday (November 1). Employment and inflation data influence the Fed’s assessment of economic conditions and subsequent policy decisions, especially given the market turmoil caused by non-farm data since August.
Next week, the U.S. elections (November 5) and the Fed meeting decision (November 7) will take center stage, potentially causing significant volatility across all risk assets, not just the bond market. Investors might stay attentive.
Additional Disclosures: This content is also not a research report and is not intended to serve as the basis for any investment decision. The information contained in this article does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Furthermore, there is no guarantee that any statements, opinions or forecasts provided herein will prove to be correct.
Options trading involves substantial risks and may not be suitable for all investors. Losses could potentially exceed your initial investment. Please also consider our US Options Product Disclosure Statement (PDS), US Options Target Market Determination (TMD) and OCC's Characteristics and Risks of Standardized Options available on the website before trading options.
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