In a rare turn of events, bond funds are a hot item now. Yet, unwary traders could end up getting trapped if they buy the iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT). I am bearish on TLT stock, and unfortunately, I expect that some investors will end up losing money because they don’t really know what TLT is or does.
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I’m informally calling it TLT stock, but actually, it’s an exchange-traded fund. The fund is managed and operated by established ETF provider iShares.
The name of the 20+ Year Treasury Bond ETF indicates that it’s related to U.S. government bonds, but this can be deceptive due to the relationship between bond prices and yields. Furthermore, some financial traders might look at TLT stock and think that it’s cheap and, therefore, ought to be bought. Caution is advised, though, since central bank policy could put ongoing pressure on TLT for the foreseeable future.
What’s in the TLT ETF?
A quick glance at TipRanks’ TLT ETF holdings page reveals that the fund holds a variety of long-term Treasury bonds. Currently, the bonds held by the fund have various maturity (i.e., expiration) dates between 2040 and 2055.
Here’s why so many people are confused about TLT stock. When bond yields go up, bond prices go down. The opposite is also true — bond yields going down means that the prices of those bonds will go up.
TLT is a bond ETF, yes, but it follows bond prices, not bond yields. Therefore, if you expect long-term Treasury bond yields to go up, it won’t make sense to buy TLT stock.
Now, you might be thinking that you could short-sell TLT stock if you think that long-term Treasury bond yields will go up. Bear in mind, though, that usually, there are borrowing costs as long as you’re short-selling a stock or an ETF. Since the Federal Reserve hiked interest rates numerous times in 2022 and 2023, the borrowing costs for short-selling are now quite elevated.
In the U.S., your broker might charge you a margin (i.e., borrowing) rate of 15% or more per year to short TLT. Moreover, since TLT stock tends to move slowly, you could end up losing money even if TLT stock goes down like you hoped it would. It’s like trying to fight someone while walking up a steep hill — not so easy to win.
Frankly, if you’re looking at TLT stock as a fixed-income investment that works like a government bond, you’re barking up the wrong tree. I believe the best way to get “risk-free” income of around 5% over the next year is just to buy government bonds directly rather than trying to achieve the same results from the TLT ETF.
Fed Policy is Likely to Push TLT ETF Lower
So far, I’ve explained what the iShares 20+ Year Treasury Bond ETF does and why many financial traders should probably avoid it. Why would I be bearish on TLT stock, though? The answer is that I expect Federal Reserve policy to put upward pressure on bond yields and, hence, downward pressure on TLT.
I’m modest enough to admit that I have no idea what Federal Reserve Chairman Jerome Powell and the other central bank policymakers will do next. On the other hand, Powell did provide some clues during this month’s Federal Open Market Committee (FOMC) meeting.
At that meeting, Powell stated, “We want to see convincing evidence really that we have reached the appropriate level, and we’re seeing progress and we welcome that. But, you know, we need to see more progress before we’ll be willing to reach that conclusion.” That’s Powell’s polite way of saying that the Fed needs to see the annualized U.S. inflation rate get closer to the central bank’s 2% target before the Fed would consider cutting interest rates.
In addition, the Federal Reserve’s dot plot indicated that one more interest-rate hike is likely to occur this year. Between the data from the dot plot and Powell’s commentary, it certainly looks like a “higher-for-longer” (quoting the Fed) interest-rate policy is the most likely outcome, at least in 2023 and early 2024.
Conclusion: Should You Consider TLT Stock?
It may be tempting to look at the chart of TLT stock and decide that since the share price is already really low, it has nowhere to go but up. However, if you read between the lines in the Fed’s dot plot and Powell’s comments, you’ll likely conclude that bond yields could easily go higher and TLT could continue to lose value.
To put it another way, persistent inflation might lead to a “higher-for-longer” interest-rate policy, which in turn would suggest “lower-for-longer” TLT prices. In the final analysis, it’s important to fully understand what any fund actually does before you think about buying it, and I believe TLT ETF is not worth considering right now.
