U.S. 10-Year Treasury To Decline 5%-Plus In Price When European Macro Concerns Go Away

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Includes: IEF, TLH
by: Richard Shaw

Morgan Stanley today said that it calculated 60 basis points of rate suppression on the U.S. 10-year Treasury due to safe haven seeking behavior relating to the European debt crisis. They said when that situation calms, the 10-year bond rate should rise by 60 basis points. That implies a 5%-plus decline in the price of the bond.

At the current rate of 2.06% for the 10-year Treasury bond, the duration is about 9.1 years. By the McCauley rule-of-thumb that bond prices change by the number of percentage points change in rate times the duration, you arrive at an expected 5%-plus price decline (0.6 X 9.1).

For the Treasury ETFs that straddle the 10-year maturity (IEF and TLH), reduction in European credit problems implies reduction in the price of those ETFs.

IEF covers 7-year to 10-year Treasuries (duration 7.37 years, SEC yield 1.78%).

TLH covers 10-year to 20-year Treasuries (duration 10.10 years, SEC yield 2.48%).

Because those funds have a mixture of maturities and funds flow, a straight forward application of the McCauley duration formula is less reliable than on a single Treasury bond. But you can still visualize a negative price change that would "eat" more than a year's income from those funds if the 10-year Treasury rate rose 60 basis points - if things actually improve in Europe.

Disclosure: QVM does not have positions in any mentioned security as of the creation date of this article (November 16, 2011).

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