TLT: Only To Lower Portfolio Volatility

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Hale Stewart
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Summary

  • CPI and the PCE price index are elevated.
  • The Fed still thinks inflationary pressures are transitory and therefore will dissipate by next year.
  • The TLT recently broke support on news that the Fed would end its bond-buying program.

Black Bull and Bear

peterschreiber.media/iStock via Getty Images

In looking at treasury market tracking ETFs, I look at inflation and general central bank policy following by an analysis of the ETF's charts.

Let's start by looking at inflation.

CPI and Core CPI

CPI and Core CPI

CPI (or inflation) has been prominently discussed in the news of late due to the spike seen in the above chart. This has largely been caused by the problems from stopping and then restarting an economy, combined with the continued effects of some governments reinstituting lockdowns to slow the virus spread. As a result, inflation (overall in blue and core in red) is at its highest level in the last few decades.

PCE Overall and Core Indexes

PCE Overall and Core Indexes

The PCE price indexes (which are broader than CPI and therefore used by the Fed) are exhibiting the same behavior.

The Fed is still of the opinion that these price spikes are transitory. From Chairman Powell's most recent testimony (emphasis added):

Inflation is elevated and will likely remain so in coming months before moderating. As the economy continues to reopen and spending rebounds, we are seeing upward pressure on prices, particularly due to supply bottlenecks in some sectors. These effects have been larger and longer lasting than anticipated, but they will abate, and as they do, inflation is expected to drop back toward our longer-run 2 percent goal.

Governor Bainard agrees (emphasis added):

Next let's consider price stability. Inflation is currently elevated. This is creating challenges for consumers and businesses alike. But the high inflation readings from the spring and early summer were disproportionately driven by a few sectors experiencing specific supply bottlenecks. In May and June, new and used vehicle prices accounted for half of the outsized monthly increases in core consumer price index (CPI) inflation. These categories were lesser contributors in July, and in the August CPI their joint contribution declined to essentially zero, as prices finally began to retreat for used cars, offsetting increases in new car prices.

.....

The currently elevated level of inflation is driven by COVID-related disruptions. As these COVID-related disruptions subside, most forecasters expect inflation to move back down toward the Federal Reserve's 2 percent long-run objective on its own. That is the sense in which currently high inflation is likely to be transitory. In that regard, the August monthly CPI reading was the first month with a notable retrenchment among COVID-sensitive categories like hotels, used cars, and rental cars.

Powell and Brainard aren't the only Fed presidents with this opinion. In fact, it's shared by all Fed Members:

Fed Economic Projections

Fed's Economic Projections

The above table is from the latest Federal Reserve press release. The third row down shows the Fed's inflation projections for the next four years in various incarnations. Notice that the median and central tendency (which strips out extreme readings) all show lower inflation in 2022. But on a cautionary note, the range (far right section) shows higher projected levels in 2022.

Finally, here is the dot plot (which shows where Fed presidents see interest rates in the coming years) from the latest Fed report:

Dot Plot interest rates in the coming years

Dot Plot

No president sees rates rising this year. But more think rates will be higher next year. But, also note that the highest projected rate is only .75%.

Fed conclusion: the Fed still believes that inflation will move lower by the end of next year. They are projecting rate increases, but even with those, overall rates will still be low by the end of next year.

Two charts are relevant for this analysis:

TLT Weekly chart

TLT Weekly - stockcharts.com

The weekly chart shows the end of a very long treasury market rally, which ended at the end of last year. Prices fell to the 200-week EMA, which twice provided support. Prices moved a bit higher in the early summer and then consolidated around the 61.8% Fib Level.

TLT Daily chart

TLT Daily - stockcharts.com

The daily chart provides more detail of the latest price activity. There's a clear consolidation in August. But prices broke through support on higher volume last week.

Currently, there is little reason to see a major rally in the TLT. Although inflation is rising, the Fed is also on record as saying rates are going higher, which, by definition, makes today's bonds less valuable. But, there's little reason to see a major sell-off (10%+) at this point. The Fed still has a great deal of inflation-fighting credibility. I could see a 5% downside at this point but in a fairly disciplined sell-off. That would take the ETF down to about 137.5.

So right now, only add this to your portfolio for two reasons: to lower overall portfolio volatility while also getting a modest income stream.

This article was written by

Hale Stewart profile picture
10.59K Followers
Hale Stewart spent 5 years as a bond broker in the late 1990s before returning to law school in the early 2000s. He is currently a tax lawyer in Houston, Texas. He has an LLM in domestic and international taxation (MagnaCumLaude). He is the author of the book The Lifetime Income Security Solution. Follow me on Twitter at @originalbonddadYou can read his legal analysis on his law office's blog.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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