TMF's Leveraged Exposure To Long-Term Treasuries Will Benefit From Rate Cuts

seekingalpha08-26

Recent market conditions have sparked interest in long-term Treasury bonds due to probable rate cuts by the Federal Reserve.Treasuries provide steady income, a hedge against stock market drops, and ...

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Last week, Jerome Powell, Chair of the Federal Reserve, gave a speech where he indicated that the time has come to begin cutting interest rates, largely due to lower levels of inflation and higher rates of unemployment. Given this confirmation, it appears increasingly likely that Treasuries shall perform well in the coming months and quarters. If this is the case, it is likely a good time to allocate to the Direxion Daily 20+ Year Treasury Bull 3X Shares ETF (NYSEARCA:TMF). Long-term Treasury bonds provide a steady stream of income through their interest payments, and they cannot be called back like most bonds and CDs. Treasuries are also among the safest and highest-rated securities any market offers, as they are guaranteed by the U.S. government, and backed by its ability to tax and print dollars. Alternatively, most investments from non-government entities are legally prohibited from making such express guarantees. Bonds also serve an important function as a hedge that can balance the risk from equity investments in a portfolio. Usually, when the stock market drops, Treasuries benefit from a flight to safety. While this capacity to hedge has not been exceedingly evident over the last few years, as interest rates climbed and bonds lost value, that was likely due to prior rock bottom interest rates and the significant level of risk that was associated with long-term fixed income at rates below two percent. Now, bonds offer a more compelling interest rate, plus the potential to increase in value if rates should decline. Over the last three years, the Federal Reserve aggressively raised interest rates to combat inflation, and then let them remain at some of the highest levels seen since prior to the great financial crisis that started in 2008. This also pushed up yields on long-term Treasury bonds, making them a better provider of income. Federal Funds Effective Rate Chart (St. Louis Federal Reserve: https://fred.stlouisfed.org/series/FEDFUNDS) Increasing rates as the Federal Reserve did also reduced the valuation of existing fixed income assets, including Treasuries and mortgage securities. Those declines hurt banks and likely were a primary cause of the failure of some banks. This was and continues to be a major concern for the Federal Reserve. Similarly, this caused a freezing within certain real estate markets, where would-be buyers are waiting for lower rates, and existing mortgage holders often feel unable to sell their property and effectively obtain a reasonable new mortgage. This is especially the case in certain commercial real estate markets, such as class-C office buildings. Beyond the apparent need for interest rate relief, there are other reasons to anticipate future Treasury strength. Global economic conditions are uncertain, and the list of market risks is far longer than just the rate of inflation and a possible recession. There also exists serious concerns around ongoing geopolitical tensions, including actual conflicts occurring in Europe and the Middle East. In such environments, and especially when escalation occurs, investors are likely to seek the safety and stability of Treasuries. While the market recently repriced the probability of a forthcoming rate cut cycle, there still exists a great deal of uncertainty regarding the pace at which the Federal Reserve may lower rates within 2024. Since last year, the market has presumed that some rate cuts were likely in 2024, and some analysts even anticipated rate cuts early in the year. While it now appears somewhat probable that the Federal Reserve will begin its rate cut cycle in September, that is still uncertain, and it is also unclear how many cuts are likely in the following months, as well as how deep those cuts may be. Even though Treasury bonds have approached their highest valuations in a few months, it is likely that there is considerably more room for them to move over the next year. Long-term bonds are not likely to fully price in an anticipated move due to the significant effect a change in yields has upon high-duration fixed income. For example, if the rates 20-year Treasuries pay were to decline by 100 basis points over the next year, the value of an existing 20-year Treasury is likely to appreciate by about 19 percent between now and then. The very opposite occurred over the last few years, as rates climbed, causing bond values to plummet. The weekly TMF chart shows the significant losses that this 3x leveraged ETF sustained as rates climbed. TMF declined from the low $300s in late 2021 until finally bottoming in October 2023, as prices were in the high $30s. Since then, while appreciating, TMF and underlying Treasuries have remained rangebound. TMF weekly candlestick chart (Finviz.com) The above chart also shows that TMF is gaining some momentum as we approach a probable initiation of the rate cut cycle. Shares did not cross above their 50-day simple moving average until late July. Since then, shares have attempted to break out of their midterm trading range. TMF daily candlestick chart (Finviz.com with redline by Zvi Bar) TMF almost broke above resistance at the start of August, when volatility spiked, but subsequently sold off. Nonetheless, TMF remained above its moving averages and has since begun to again climb back towards resistance, at about $61.50. I expect TMF will follow treasuries higher, and soon break out and above that resistance point, and potentially into the mid-$60s in anticipation of the forthcoming rate cut cycle. Gains should be substantially greater if the Federal Reserve were to start this rate cut cycle with a 50 basis point move, where a 25 now appears expected. Similarly, TMF could go much higher if the equity markets were to tank, and volatility spikes, prompting a longer-term flight to safety. Risks While long-term Treasuries present opportunities, they come with risks. The primary risk is interest rate risk. If interest rates rise, the price of existing bonds falls. Long-term bonds also suffer from duration risk, which amplifies the effect of rate changes. In essence, the change in rates is multiplied by the bond's time until maturity. While this appears to be a benefit at the moment, where rates are presumed to decline, it was previously a liability, and could again become one. Another risk to long-term bonds is the opportunity cost associated with making what is often considered a risk-off investment. Locking money into a long-term bond could mean sacrificing potential returns from other investments. Given the leveraged nature of TMF, it has the potential to move significantly more than underlying Treasuries. That triple leveraging should be expected to result in three times the move, but the move can be amplified by consecutive days of oversized movement in either direction. As a result, such leveraged ETFs are not great long-term holdings, but may be well suited for short and midterm speculation on a meaningful move. Further, their higher management fees make them poor choices for extended holding periods. Conclusion  TMF appears likely to soon break out and trade above its resistance in the low $60s. After doing so, it also seems probable that TMF is likely to continue to appreciate in late 2024 and into 2025 as the Federal Reserve initiates a series of rate cuts. I anticipate TMF will break through $65 in advance of the start of the forthcoming rate cut cycle, and that it has the potential to move much higher depending upon the speed at which the Federal Reserve chooses to cut rates, as well as due to possible equity market weakness later this year. Further, Treasuries were to have a period of weakness shortly before the national election in November, I believe that will become a good opportunity to add exposure in advance of a likely aggressive rate loosening cycle in 2025.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"1","news_tag":"policyRegulatory","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":1,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.4","shortVersion":"4.29.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2462912350"}