This week may prove to be hectic for bond traders. After 10-year yields broke the pivotal 1% level last week as Democrats secured the majority in the Senate, yields continued to rise. Treasury yields closed the week on the upper resistance line of the trend channel they have been trading in since August. If they break above this level, they will trigger a selloff that could push them to try the next resistance line at 1.2%.
This week, the focus will be on Federal Reserve speakers as the market is still trying to digest December's FOMC minutes released last week. The report showed that although there is no intention to alter the bond-buying purchasing program, tapering is starting to be discussed. At this point, any mention to tapering cannot be ignored, mainly because things have profoundly changed since Democrats secured the Senate furthering the reflation story. In a speech last week, Fed's Raphael Bostic said that if the U.S. economy gets strong, the central bank might taper earlier than expected. Bostic is speaking twice this week: today and on Thursday. For bond investors, it is crucial to understand whether the Fed could envision earlier tapering. It is enough for tapering expectations to be moved forward to 2022 for the market to continue to sell off and the U.S. yield curve to bear-steepen.
We see more downside for Treasuries across the yield curve at this point of time. Firstly, real yields are deeply negative meaning that investors are losing money by holding nominal Treasuries. Secondly, low yields are causing Treasuries to be highly price-sensitive, especially for long durations. In just five trading days, 10-Treasury yields moved up by about 20 basis points, representing a loss of around 2% for bondholders. Thirty-year Treasury yields moved up by 23bps inflicting a loss of 5% on bondholders.
While there is a large room for downside, any upside is limited as the Fed is unquestionably not looking to cut the benchmark interest rate below zero. Hence, we remain underweight ETFs exposed to long-duration such as the iShares USD Treasury Bond 20+yr UCITS ETF (TLT) and the iShares Barclays 10-20 Year Treasury Bond Fund (TLH). At the same time, we continue to favour inflation-linkers such as the PIMCO 15+ Year US TIPS Index (LTPZ) and PIMCO Broad U.S. TIPS Index Fund (TIPZ).