Is The Treasury Bond ETF Rally About To End?

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Includes: EDV, IEF, TLH, TLT, ZROZ
by: Zacks Funds

The dream run of the 30-year-old bullish bond market finally seems to be approaching its end. At least, the latest pool of U.S. economic data and president-elect Donald Trump’s promises give such indications.

Benchmark U.S. Treasury bond yields rose to 2.22% on November 16 from 1.88% on the election day causing a global bond market rout. The U.S. has not seen a 2% benchmark yield in over nine months.

Why Yields Are On Uptrend

Trump’s vows to cut taxes and boost fiscal spending raised inflation expectations, pushing bond yields higher. Speculation is rife that business investments will a get a new lifeline now. Plus, during his campaign, Trump indicated that he will provide a repatriation holiday of 10%.

The Trump tax plan is to lower the top income tax bracket from 39.6% to 33%, eradicate alternative minimum tax, slash corporate income tax by more than half and remove estate tax, as per the source. There are talks that he is expected to offer $137 billion in tax credits to private construction companies undertaking infrastructure projects.

Though U.S. industrial output was unchanged in October reflecting a downbeat mood, retail sales came in better than expected.

The dollar index already hit its highest since April 2003. Chances of a Fed rate hike in December jumped to 90% from 75% prior to the election. If the Fed acts in December, Treasuries – which are already timid in the Trump world – may see another round of steep sell-off.

Why Some Experts Bearish on Bonds

A group of experts has been predicting an end to the 30-year bond rally in recent times. For example, mutual-fund manager Bill Miller viewed stocks trading at 3% to 4% of discounts, “based on the old Federal Reserve model of valuing securities, where the earnings yield on stocks and the yield on the 10-Year Treasury, should be about the same for fair value.” So, this discount can trigger a great rotation from bonds to stocks.

2.5% Benchmark Yield Near at Hand?

Though it is yet to be seen how many promises made in the election campaign materialize eventually, market watchers have started to price them in. As per HSBC, the U.S. 10-year yield may jump to 2.5% by the first quarter of 2017. The projection was based on the historical trend of the 10-year yield trading “at least 100 basis points above the 2-year yield.”

The research agency here considered a Trump premium of about 100 bps, reflecting a rising inflationary outlook. Goldman Sachs (NYSE:GS) and BAML also project that the 10-year U.S. yield could rise to 2.50%. With this level of yield projections doing rounds, more sell-off is in the cards.

ETFs in Focus

U.S. Treasury bonds, which had a dream rally in the initial part of the year, succumbed to a sharp sell-off recently. In the last 10 trading sessions (as of November 16, 2016), U.S. treasury bond ETFs like Vanguard Extended Duration Treasury ETF (NYSEARCA:EDV), PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (NYSEARCA:ZROZ), iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT), iShares 10-20 Year Treasury Bond ETF (NYSEARCA:TLH) and iShares 7-10 Year Treasury Bond ETF (NYSEARCA:IEF) lost considerably.

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