In an October 9 Barchart article that highlighted “Carnage in the bond market,” I wrote:
Even the most aggressive bearish markets rarely move in straight lines, but the bond bear is approaching its fourth anniversary, with the trend picking up steam over the past weeks. The recent slide could mean a bounce is on the horizon. Fighting the bear is a contrarian approach that requires a prudent risk-reward approach and discipline to guard against getting financially mauled.
In late October, the U.S. 30-year Treasury Bond futures reached what was an unsustainable low at 107-04 before recovering to the latest high above 123. While the long-term trend remains lower, the bonds ran out of bearish steam and have moved into a short-term bullish trend. The iShares 20+ Treasury Bond ETF product (TLT) tracks long bond futures.
The long bond futures fall to a low and reverse
Long bond futures have trended lower since the Mach 2020 pandemic-inspired high.
The five-year chart highlights the pattern of lower highs and lower lows since early 2020. The latest 107-04 low in October 2023 created the perfect environment for a short-covering rally, as the overwhelmingly bearish sentiment and proliferation of speculative short positions caused the market to run out of selling. The long bond futures reached 123-29 on Thursday, December 14.
The Fed continues to pause
Over the past months, inflationary pressures have declined, leading the U.S. Federal Reserve to pause Fed Funds Rate hikes. The FOMC had increased the short-term interest rate from zero percent in March 2022 to 5.375%. However, declining inflation has caused the central bank to pause its aggressive rate increases at the past three FOMC meetings.
The central bank has responded to the improving CPI and PPI data by taking its foot off the credit-tightening pedal. Market sentiment has shifted to bullish in the bond market as market participants believe the Fed is just above done with credit tightening. While the Fed members continued to talk more hawkishly than dovish over the past months, the action spoke louder than the words. The FOMC statement and Chairman’s press conference were decidedly dovish, as the Fed shifted its monetary policy path. The potential for 2024 rate cuts increased after the December FOMC meeting.
The technical levels to watch
The ten-year chart of the U.S. 30-year Treasury Bond futures shows room for further rallies over the coming months as the central bank is becoming less hawkish and rates have stabilized.
The chart shows the first technical resistance level is at the April 2023 134-14 high. At just below the 120 level on December 15, the long bond futures are around the midpoint of the April 2023 high and the October 2023 low. The next move depends on the Fed and inflationary data over the coming months.
The case for lower rates in 2024
The U.S. central bank’s inflation target remains at 2%. While inflation remains over the 3% level, it has declined from much higher readings over the past months. The case for lower rates in 2024 includes:
- 2024 is a U.S. election year, and the Fed will take a conservative stance to avoid political interference in one of the most contentious elections.
- The trajectory of rate hikes in 2022 and 2023 was dramatic. Even if the Fed inflation causes increases in short-term rates over the coming months, the central bank can only pull the trigger on one or two 25-basis point hikes without damaging economic growth and pushing the U.S. into a severe recession.
- Higher rates over the past two years have increased financing costs for home and automobile purchases and consumer credit. The Fed will likely allow markets to adjust to the new credit environment without further rate hikes.
- Funding the $33.9 trillion U.S. national debt at 5.375% now costs more than $1.8 trillion annually. Each 25 basis point increase causes debt servicing to rise by nearly $85 billion.
- Fed rate hikes and quantitative tightening take months, if not years, to filter through the economy. The central bank may allow the rate hikes and balance sheet reduction over the past two years to continue to work on reducing inflation.
The Fed’s mandate is full employment and low inflation. After an aggressive period of credit tightening, the data-dependent central bank is taking a wait-and-see approach in 2024, with little or no rate adjustments. Meanwhile, any economic turmoil caused by geopolitical events or other systemic shocks could cause interest rate cuts as the Fed has increased them to levels that leave room for downside adjustments.
TLT is a liquid product- Levels to watch
While the long bond futures fell to a sixteen-year low in 2023, the odds favor a challenge of upside technical resistance in 2024. I expect the bullish trend that began in October 2023 to continue over the coming weeks and months.
The most direct route for a risk position in long-term government interest rate markets is the U.S. 30-year Treasury Bond futures and futures options. The iShares 20+ Treasury Bond ETF product (TLT) provides an alternative for market participants seeking exposure to U.S. government long-term interest rates.
At $98.74 per share on December 14, TLT had over $45.844 billion in assets under management. The highly liquid ETF trades more than 47.2 million shares daily and charges a 0.15% management fee.
As the chart illustrates, TLT followed the long bond futures to a low in October 2023, reaching $82.42 per share. The 20% rally took the ETF to a $98.95 high on December 14. At over $94 on December 15, TLT is close to the recent high. Technical resistance is at the December 2022 $109.68 high and the August 2022 $120.69 peak.
Like the bond market, TLT has room to rally in 2024 as the potential for further aggressive Fed interest rates is limited and the odds of rate cuts have increased. In late 2023, the paths of least resistance for bonds and the TLT are higher.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
