TLT in Peril as Bond Yields Look Set to Resume their Ascent amid High Inflation
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TLT ETF OUTLOOK:
- TLT could trade lower over the medium term as long-term Treasury yields resume their ascent amid high inflation and Fed tightening
- While geopolitics remain a risk to the recovery, the U.S. economy remains strong, so traders should not yet position for a major downturn
- The recent flatting of the yield curve is worrisome, but the extreme moves have been exacerbated by risk-off sentiment
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Most read: Gold Prices Hit 14-Month High Amid Ukraine Crisis, Falling Real Yields
Treasuries have gained in recent weeks amid sustained appetite for safe-haven positions on rising geopolitical tensions in Eastern Europe after Russia began its unprovoked invasion of Ukraine, shelling cities across the country to topple the government.
As a result of the market turbulence, the TLT ETF (iShares 20+ Year Treasury Bond ETF) is up almost 4% from its February lows, following the steady decline seen since early December of last year. Yields, which move in the opposite direction of government bond prices, have fallen over the time period in question, with the 30-year rate dropping from 2.38% to 2.15% and the 10-year falling from 2.06% to 1.77%. The short end of the curve has also repriced lower, but the retracement has been more measured due to the impending Fed liftoff.
Geopolitics dynamics have accelerated the flattening of the yield curve, bringing the 2s10s to its lowest level since March 2020 and just 35 basis points from inversion, an ominous sign for the economy, at least from a bond market perspective. The shape of the yield curve is a leading indicator and has strong predictive power, but traders should understand that recent changes have been driven in part by risk-off sentiment and extreme volatility, and may reverse in the near term once the situation in Eastern Europe begins to ease.
2S10S TREASURY CURVE
It is important to recognize that the Ukrainian crisis is a human tragedy of massive proportions, but it may not necessarily derail the recovery on this side of the Atlantic. In fact, the U.S. economy remains strong, supported by a robust labor market. Although we hit a rough patch late last year due to the Omicron wave, hiring appears to be accelerating again, as the private sector added 509,000 and 475,000 jobs in January and February, respectively, according to ADP.
With a solid labor market, an under-leveraged consumer, positive outlook for inventory rebuilding and still favorable financing conditions, the economy should perform well in the coming quarters. This could translate into higher yields across the curve, but increases in the short end could moderate, as the FOMC may be reluctant to withdraw stimulus too aggressively in light of growing uncertainties in the geopolitical landscape.
Based on the belief that long-term yields will resume their ascent, especially as inflation continues to rise, I remain bearish on TLT (long-term bond prices will fall if yields rise), viewing rallies in this specific ETF as an opportunity to position for a pullback. That said, it's probably only a matter of time before the TLT’s yearly low in the 134.00 area is re-tested.
TLT DAILY CHART
TLT Chart Prepared Using TradingView
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---Written by Diego Colman, Contributor
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.