Persistent Bond Fund Bonanza Indicative of Increasingly Aggressive Bets on US Treasury Yield Trajectory

Record monthly volume in a key US bond fund throughout October was symptomatic of burgeoning interest in US treasuries among speculators who anticipate a rampant run-up in long-term yields to abate soon. Though investors have been taking big losses on such bets this year, the yield on 10-year US Treasury bonds has reversed course over the past few weeks, following its breach of the 5.0% mark in mid-October. Declining yields have coincided with early signs that the resilient US job market could finally be giving way. The Federal Reserve has continually warned that economic activity is likely to slow in the wake of their monetary policy tightening. 

Despite the Fed projecting one more hike before year-end, traders have largely priced in zero further hikes before eventual rate cuts in 2024. This potential shift at the central bank would likely break the incessant downward pressure on bond prices that is expected to push many bond fund managers into annual losses for an unprecedented third straight year. However, the flooding of Treasury markets with a wave of debt to finance expanding US government deficits, along with fleeting exposure to US debt among foreign institutions, may keep yields elevated.

Related ETFs: iShares 20+ Year Treasury Bond ETF (TLT), ProShares Short 20+ Year Treasury (TBF)

After the 10-year yield on US Treasury Bonds reached a five handle for the first time in sixteen years last month, the previously rapid run-up in long-term rates suddenly began to subside as bond prices rallied to start November. This reversal was a sigh of relief for investors that had been piling into the long-dated Treasuries trade for several months – absorbing significant losses along the way. One of the most popular ways to gain exposure to long-dated treasuries has been the iShares 20+ Year Treasury Bond ETF (TLT), attracting a record $17.6 billion so far in the year to mid-October. Bloomberg estimates put losses for TLT investors in that period above the -$10.0 billion threshold. Monthly volume on the TLT was just shy of $100.0 billion in October, a record for any bond ETF, and underscoring the increasing the interest of speculators in the bond space, which has been suppressed for years. Reuters reports that US diversified bond funds are on track for a third year of negative returns, after losing more than -10.0% in 2022. For many bond fund managers, this is the first time they’ve ever experienced three straight years of losses.

A significant portion of the resurgent pressure under long-term bond prices is related to the impending end of the Federal Reserve’s rate hike cycle – having left the benchmark Federal Funds rate unchanged in three of the past four meetings. Though the Fed’s most recent projection materials, released in September, show the median expectation among members of the Federal Open Market Committee (FOMC) to be one more 25bps hike before year-end, traders have largely priced this last hike out of futures contracts tied to the Fed Funds rate. As of Monday morning, the CME’s FedWatch showed a greater than 90.0% probability of no hike at December’s FOMC meeting, the final gathering of the Fed’s decision-making council before year end. In fact, the CME’s gauge of current market positioning shows little chance of any further hikes going into 2024, suggesting the Fed has already reached its terminal rate. FedWatch indicates that the probability of a Fed Funds rate cut begins to outweigh the chances of a hike by…