Last year’s hottest bond ETF is plunging – whacking investors who misjudged inflation.
Like most bond ETFs, the iShares 20+ Year Treasury Bond ETF (IDTL) fell to fresh 2024 lows last Wednesday following the release of an unexpectedly hot Consumer Price Index for March. The interest rate-sensitive ETF dropped 1.3%.
IDTL is now down 7.1% this year, erasing its gain of 2.8% from last year and then some.
It is a striking decline for an ETF that was among the most popular in 2023. Investors added $3.8bn to IDTL last year amid expectations the Fed would vanquish inflation and rates would swiftly decline.
Heading into 2024, those assumptions were looking good. Growth in the core personal consumption expenditures price index – the Fed’s preferred measure of inflation – had decelerated sharply, even falling below 2% on a six-month basis.
The core consumer price index was running a bit higher, but it too was headed in the right direction.
Encouraged by that data, investors priced in six rate cuts for 2024 at the start of the year, while the 30-year Treasury bond yield briefly fell below 4%.
Inflation perks up
Quickly, however, investors realised the path for inflation would not be a straight line down.
Consumer prices rose faster than expected in January, February and March.
For three straight months, the core CPI grew by 0.4% on a month-over-month basis, an annualised rate of nearly 5%.
Meanwhile, the core PCE, which puts less emphasis on shelter costs, increased by 0.4% in January and 0.3% in February – consistent with inflation in the 4% range (the data for March will be released on 26 April).
These numbers have returned inflation worries to the forefront, causing investors to reevaluate when, or even if the Fed will cut rates this year.
Following Wednesday’s CPI release, the pricing of Fed funds futures indicates there is an 80% probability that the Fed will hold rates steady at its June meeting, while there is a 55% probability it will keep rates on hold in July.
The futures market now expects only two rate cuts this year, less than even the Fed was projecting in its last Summary of Economic Projections from March.
Some are even abandoning the possibility of rate cuts altogether. Minneapolis Fed President Neel Kashkari said last week that the central bank might not need to cut rates if inflation stays elevated and the economy remains strong.
While certainly not the consensus view, fed funds futures are pricing in an 11% probability of no rate cuts this year.
IDTL's path
Whether it’s a small obstacle or something more lasting, the acceleration of inflation in 2024 has hit IDTL particularly hard.
The 30-year Treasury bond yield reached 4.6% on Wednesday, its loftiest level since November, and a gain of 65 basis points compared to where the yield bottomed out late last year.
If inflation remains hot, yields on the 30-year could approach their highs from last year of around 5.1%.
That would likely require investors to abandon hopes for any rate cuts this year.
Yields could also move even higher than last year’s peaks, pushing IDTL to fresh 20-year lows.
That scenario probably hinges on a notable and persistent acceleration in inflation that pushes the Fed to hike rates again (though it could happen even without Fed rate hikes, say, if the yield curve steepens and the 30-year yield tops the Fed funds rate).
Bull case
But as gloomy as the outlook for IDTL looks today, all hope isn’t lost.
Three months of elevated consumer prices, while disappointing, does not necessarily mean we are back to square one with inflation.
Ever since inflation ignited in 2021, there have been plenty of ups and downs in consumer prices. It is certainly possible that the high core CPI and PCE readings of the first quarter are temporary obstacles to 2% inflation.
And even if they are not, inflation could stay modestly higher than what the Fed would like, but still far below its peaks of 2021 and 2022.
This article was originally published on ETF.com
