Record 38% Drop in Bond ETF Leaves Bearish Traders Exhausted

Record 38% Drop in Bond ETF Leaves Bearish Traders Exhausted

(Bloomberg) — A brutal wipe out in a $25 billion bond-traded fund has investors betting that the worst is over on the eve of a crucial Federal Reserve decision.

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According to data from Bloomberg, the price of the iShares 20+ Year Treasury Bond ETF (ticker TLT) is down 38% since its peak in August 2020 in the biggest drop since the fund’s inception in 2002. Meanwhile, data from IHS Markit shows Ltd. that short-term interest rates as a percentage of TLT’s outstanding shares fell to a record low of 0.15% on Monday, after hitting 13% earlier this year.

All things considered, the statistics suggest a desire to get back into Treasuries as the Fed targets the highest inflation rate in a generation. Towering price pressures have rocked the fixed income markets and brought down TLT, among other things. However, as concerns mount that curbing inflation will come at the expense of economic growth, rising government bond yields appear to be an entry point, according to Richard Bernstein Advisors. Low on expectations for a rocky corporate earnings season, and the treasury market pull is even more appealing.

“Nobody is willing to bet on higher interest rates when growth is rolling and the Fed is determined to slow the economy and inflation,” said Michael Contopoulos, director of fixed income at Richard Bernstein Advisors. “The fact that all this is happening as we are about to enter an earnings recession only makes investors even more afraid of going short on the long end.”

The price of TLT is down nearly 29% so far in 2022, putting the ETF on track for its worst year on record. Despite the disastrous performance, investors have put nearly $12 billion into the fund so far – another year-on-year record. It’s a similar dynamic in the ETF arena of bonds, which have absorbed $118 billion in inflows this year, though nearly 95% of funds are absorbing losses.

The Fed is widely expected to unleash a third straight increase of 75 basis points at Wednesday’s meeting, alongside policymakers’ new forecasts for the economy. Traders, however, were counting on the possibility that the central bank could raise interest rates by a full percentage point after August inflation data came in higher than expected.

While ETF traders seem poised to buy the dip in bonds, Todd Sohn of Strategas Securities says such a move would be premature.

“Perhaps some believe the worst of the withdrawal is done,” said Sohn, ETF strategist at Strategas. “But if we have any more surprises — pick a reason: inflation, geopolitical issues, and so on — then there’s one more leg to go.”

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