The best time to buy TLT, the popular bond ETF, was last October. The second best chance is now.
Context: In October last year, we argued that the bond bear market had come to an end. Following a low of 0.4 percent in March 2020, the US 10-year yield surged to 5.0 percent at its peak. TLT experienced a 50 percent decline in value over three years.
After Treasuries endured their third consecutive annual loss in 2023, we speculated that there likely won’t be a fourth. TLT is currently down 11 percent year-to-date.
But: Isn’t inflation reaccelerating?
In December, core PCE inflation was running at a 1.6 percent annualized rate over the previous three months. We don’t have data for April yet, but as of March, the three-month annualized rate is 4.4 percent.
Our take: We believe the general downward trajectory of inflation is more important than the three straight months of elevated inflation.
Core PCE inflation has halved from its February 2022 peak and currently sits at 2.8 percent. Treasury inflation-protected securities, or TIPS, maturing in both five and ten years are pricing in inflation of 2.4 percent, implying that expectations are well anchored.
What’s happening: Costco’s product inflation hit 8 percent in 2022. According to CFO Richard Galanti, year-over-year inflation is now essentially flat.
Similarly, Walmart’s prices have remained consistent with last year’s levels. “I haven’t been able to say that for a few years now,” CEO Doug McMillan remarked. “The last few weeks, we’ve taken even more prices down in areas like produce and meat and fresh food.”
Go deeper: Approximately 80 percent of the decline in core PCE can be attributed to falling goods prices, which means the remaining adjustment must come from the stickier service-side.
With core services inflation concentrated in housing and auto insurance (both of which are lagging components of the inflation basket), and the average monthly gain in core PCE of 0.17 percent during the second half of 2023 (resulting in poor comparable for year-on-year numbers), the disinflationary process will unfold gradually.
Get smart: Pay more attention to the labor market.
Wage growth is decelerating, accompanied by a significant decline in the hiring rate. Full-time employment is down fourth months in a row.
Although S&P Global’s Flash Composite PMI indicated that the US economy is humming along, manufacturing and services businesses saw slower demand, with a drop in employment among services firms for the first time since 2020.
Between the lines: As the Fed waits to confirm victory in its battle against inflation before cutting interest rates, Fed chair Jerome Powell emphasized that “an unforeseen weakening in the labor market could also necessitate a policy response.” He expressed concern that a wave of layoffs might result in “rapid increases” in unemployment.
State of play: At the end of last year, futures markets had factored in six rate cuts for 2024. Economic data recently has justified the repricing of the rate path. However, there is now a 20 percent market probability of a rate increase within the next 12 months, which appears questionable.
Investors have withdrawn from government bonds in the past month at a scale comparable to November 2015 and July 2003, both instances that signified major bottoms in the bond market.
What they’re saying: At Bank of America, Michael Hartnett has coined a new term: “Anything But Bonds,” or ABB, to sum up the market’s unanimous dismissal of this asset class.
Rick Rieder of BlackRock is reducing duration in his flagship fixed income fund. Even the former bond king, Bill Gross, has raised doubts: why own bonds when you can indulge in shorter-term assets like T-bills, enjoying yields exceeding 5 percent?
Here’s why: The 30-year Treasuries would gain more than 20 percent with a 100 basis points drop in yields, and lose less than 5 percent, including interest, if rates rose by a half-point.
Our thought bubble: We stand poised on the precipice, where a favorable inflation report, disappointing job numbers, a spike in initial unemployment claims, lackluster retail sales, or an unforeseen crisis could catch the bond market completely off-guard.
How beautifully fragile is the economy that various factors can trigger a rally in bonds with just a moment’s notice?
Buy TLT.
