It’s time to put the U.S. Treasury trade back on the shelf for now.
Back in the spring, I posted the first of many articles on the bullish outlook for U.S. Treasuries. A variety of factors drove this viewpoint at the time including signs that Treasuries had bottomed from a technical standpoint, that selling pressure had been exhausted and buying pressure was building, that increased scrutiny from the credit rating agencies would be a call to action in Washington and that the U.S. economy was showing signs of deceleration. But the key driver of this thesis more than anything else was the fact that QE2 was soon coming to an end on June 30, as Treasuries have struggled when QE is “on”, but thrived when QE is “off”. As a result, the emphasis all along has been that any position in nominal Treasuries should be viewed as a short-term trade, for at some point conditions would change warranting the need to exit the position as quickly as it was established.
U.S. Treasuries have posted strong gains over the last several months. I have used several positions to carry out this bullish Treasury view including the iShares Barclays 3-7 Year Treasury Bond ETF (IEI), iShares Barclays 7-10 Year Treasury Bond ETF (IEF) and iShares Barclays 20+ Year Treasury Bond ETF (TLT), with the TLT the primary instrument used to maximize returns from this thesis. And over the last several months, each of these allocations has been rewarded, with the IEI up +6%, the IEF up +11% and the TLT gaining a particularly robust +22% all during a time when the stock market as measured by the S&P 500 has been down -3%.
But following Thursday’s explosive move higher in the stock market, the time has come to exit the Treasury trade. Two key factors signaled this conclusion.
First, the U.S. Federal Reserve is showing increasing determination to provide further monetary stimulus including balance sheet expansion in the coming months. Initially in early August it was the commitment to keep interested rates locked at 0% through mid-2013. Then it was the launch of Operation Twist at the beginning of October. Finally just last Thursday, the Fed began rolling out a parade of Fed Governors talking explicitly about the implementation of QE3 sometime in the not to distant future. This last wave of stimulus chatter about QE3 was enough to cause stocks to explode higher and for U.S. Treasuries to break decisively lower, which leads to the second point. Click to enlarge:
Long-Term U.S. Treasuries as measured by the TLT broke a critical support level on Thursday. Since the Treasury rally began last spring, the TLT had held support at its 50-day moving average on three different occasions along the way. And in recent days, the TLT was working to maintain support for a fourth time at this level. But once the Fed began rolling out FOMC members on successive business days to actively talk up QE3, this coupled with the announcement of an apparent agreement (at least for the moment) out of Europe was enough to break the back of the TLT and send it decisively below its 50-day moving average. This signaled an end to the U.S. Treasury trade, at least for now.
I say at least for now because the time will likely come to reinitiate the U.S. Treasury trade in the not to distant future. We’ve seen this story play out three separate times now since the beginning of the financial crisis. U.S. Treasuries rally strongly in the midst of crisis and the threat of an economic downturn. But from the moment that the Fed arrives on the scene with visions of QE, the Treasury trade breaks down. The following are the key bearish and bullish technical signals on the TLT to watch for the U.S. Treasury trade. Click to enlarge:
Bearish – The Fed sends signal that QE is on its way. The TLT subsequently breaks below its 50-day moving average and momentum indicators turn negative, both of which mark the beginning of a downtrend in Treasury prices. Such were the conditions in January 2009 and October 2010. And so too are the conditions as of Thursday.
Bullish – The Fed’s latest QE program is soon to come to an end. The TLT breaks above its 50-day and 200-day moving averages. Momentum indicators also turn positive. All of these conditions set the stage for a swift rally in Treasury prices. Such were the conditions in April 2010 and April 2011.
So the U.S. Treasury trade is over for now. The only exception would be if the TLT can reclaim the 50-day moving average in the coming days, but long TLT positions could always be reinitiated if such an outcome were to occur. Otherwise, the long Treasury trade should be put away for now. But given the seemingly endless cycles and the apparent inability of the global economy to stand on its own without considerable policy support, it’s more than likely that we’ll find ourselves back at a similar juncture toward the end of the next Fed stimulus program where it’s once again time to put the TLT trade back on. It’s only a matter of time.
So long for now TLT. It’s been a good run. And I’m sure we’ll be seeing you again sometime soon.
Disclosure: I recently liquidated all positions in IEI, IEF and TLT.
Disclaimer: This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.