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As the Greek debt crisis heats up again, interest rates on 10-year German Bunds have plummeted to 1.52% (5/9/12). This presumably reflects flight-to-safety buying by investors who want to own the debt of Europe's strongest economy, and who can blame them? The question is, how will this affect U.S. Treasury rates and, by extension, the prices of Treasury bond ETFs?

Bloomberg has an online app that allows you to compare rates for 10-year Bunds and Treasury notes at this link. After the page loads, click the "Compare" box above the chart, type in TNX, and select TNX:IND to get a comparison between U.S. and German ten-year rates. What you'll see is that since March 19 Bunds have been leading Treasuries down to ever lower lows. Over the last year, Bund rates have declined by about -50%, compared to -38% for T-notes. So the big question is, will Treasury rates continue to follow Bunds downward?

The figure below plots daily interest rates on U.S. 10-year Treasury notes from 7/1/11 to 5/9/12. What's immediately noticeable is the trading range highlighted in blue that's been in effect since the flight-to-safety buying that took place last August. Following the late summer debt-ceiling crisis and S&P downgrade of US debt, 10-year rates hit a low of 1.72% on 9/22/11. This defines the bottom edge of the current trading range. The top edge lies at 2.39% and 2.38%, reached on 10/27/11 and 3/19/12, respectively. The latter date marks the beginning of an almost continuous plunge in 10-year rates to 1.84% on 5/9/12.

(Click to enlarge)

As the table below indicates, investors who bought intermediate to long Treasury ETFs on 3/19/12 have enjoyed price gains of roughly four to twelve percent (excluding interest) during the subsequent 7+ weeks. The longer the duration the better, as Vanguard's extended duration Treasury ETF makes clear.






iShares Barclays 7-10 Year Treasury Bond Fund



iShares Barclays 10-20 Year Treasury Bond Fund



iShares Barclays 20+ Year Treasury Bond Fund



Vanguard Extended Duration Treasury ETF


But what if Treasury rates keep going lower, as Bund rates have done? The figure below shows a scatter plot of TLT's daily closing price by the daily 10-year Treasury rate for the period 3/19/12 to 5/9/12 with a trend line extrapolated to interest rates as low as 1.5%. As the two red data points indicate, if 10-year rates hit the low end of their current trading range, 1.72%, the market price of TLT could reach 120.80. And if 10-year rates follow Bund rates down to 1.52%, TLT could go as high as 124.03.

(Click to enlarge)

So what's the potential upside for TLT from here? Based on its 5/9/12 closing price of 118.87, TLT could gain another 1.62% if interest rates reach the low end of the current trading range (1.72%). But it could gain another 4.34% if 10-year Treasurys reach the current 10-year Bund rate of 1.52%.

Is this trade worth a try? Not for me, since I think Treasury rates are already too low to justify the risk. In fact, I think it may be time for investors who haven't already sold Treasurys to take some profits. But others may have a different viewpoint: my only advice is caveat emptor.

Disclaimer: This article is meant for informational purposes only and does not advise the buying or selling of any securities. I am not an investment adviser and expect you to do your own research and due diligence. Good luck!

Source: Bunds, Bonds And The Outlook For Treasury ETFs