If you think stock prices are difficult to forecast, you should get a load of bond prices. As of late, bonds have done just about everything other than cooperate with the predictions of Wall Street’s finest experts.
Venerable individuals and institutions alike have forecasted a pop in the bond market’s bubble. The past year has seen the likes of Goldman Sachs, billionaire hedge fund manager Paul Tudor Jones and the one-time “bond king,” Bill Gross, all predict a surge in the yield on 10-year U.S. Treasuries. Even ex-Fed Chairman Alan Greenspan, who has spent more than 70 years watching interest rates, wrongly predicted higher bond yields. What’s actually occurred?
Instead of rising, U.S. bond yields have been so downright berserk that it has led to a situation known as an “inverted yield curve.” This condition, which has been closely linked to economic recessions, occurred last week after the 10-year Treasury yield fell lower compared to the yield on three-month Treasuries.
While Treasury bond ETFs aren’t perfectly replicating the inverted yield curve, they’re coming close. For instance, as of March 22 the iShares Short Treasury Bond ETF (SHV) carried a 30-day SEC yield of 2.34 percent compared to a 2.44 percent SEC yield for the iShares 7-10 Year Treasury Bond ETF (IEF). SHV holds Treasuries with one year or less to maturity, while IEF holds Treasuries with seven to 10 years to maturity. Historically, the spread or difference between yields on these two instruments has hovered around 1.22 percent, according to data from YCharts.
Plummeting yields have been particularly good for investors overweighting high-yield and long-term bonds.
The SPDR Barclays High Yield Bond ETF (JNK) has jumped 7.33 percent year-to-date, while the Direxion Daily 20+ Yr Treasury Bull 3X ETF (TMF) has surged 8.69 percent. TMF’s move has been especially extreme, not to mention impressive. At the start of March, the fund, which aims for triple daily exposure to long-term Treasury bonds, was down 7 percent on the year. But since then, it has jumped more than 15 percent in value and now has a positive year-to-date gain.
Of course, most income investors stretching for yield probably aren’t trading 2x or 3x leveraged bond ETFs. Instead, they’re more likely to grab funds like JNK or the iShares 20+ Year Treasury Bond ETF (TLT) that carry higher relative yield income compared to broad market bond ETFs like the Vanguard Total Bond Market ETF (BND).
Regarding the recessionary overtures of the inverted yield curve, it’s important to understand that an economic pullback doesn’t happen after the first sign of yield inversion. In fact, on average it took 21.3 months from the actual inversion to recession, according to a four-decade study by LPL Research. During this period, the yield on 2-year and 10-year Treasury bonds inverted on five separate occasions, with the latest episode occurring from January 1, 2006 to January 1, 2008.
What are the key takeaways?
First, any predictions about the direction of bond yields or bond prices are best ignored regardless of who’s providing the forecasts.