U.S. Treasury bonds have suffered the worst year-to-date losses in more than 40 years.
A combination of soaring inflation and realized/anticipated interest rate hikes brought a decisive end to the bull market enjoyed by bonds. The low interest rate environment of the last decade has reversed, causing deep drawdowns for investors holding high fixed-income allocations.
Year-to-date, the yield on the benchmark 10-year Treasury note has jumped by over 74%, hitting a 52-week high of 3.167% briefly. Despite a brief reprieve the week of May 16-20 amid a flight to quality by investors seeking safety from equity risk, yields are now back on the rise.
The post-Memorial Day trading session on May 31 saw a 3.68% increase in the 10-year alone, sending Treasury prices on a further rout as equities tanked in unison.
Inflation continues to run high, with consumer prices jumping 8.3% in April year-over-year (YoY) because of soaring commodity prices, exacerbated by the global supply chain disruption and the ongoing Russian invasion of Ukraine.
Despite slowing down slightly from the 8.5% YoY increase seen in March, the latest inflation figure still hovers well above the Federal Reserve’s target of 2% and will likely remain so until sufficient rate hikes are implemented to quell it.
TIPS Offers Inflation Protection
Some fixed-income investors looking for protection in these market conditions have rotated into short-duration Treasurys and Treasury Inflation-Protected Securities (TIPS).
TIPS are indexed to protect investors from a sudden, unexpected surge in inflation. As prices rise, the principal is adjusted higher over time, which also increases the bond’s coupon as the interest rate is now being applied to a higher value.
TIPS can help investors avoid higher-than-expected inflation risk, which can seriously erode the yield on traditional fixed-rate Treasurys. For most bonds, the coupon rate paid is fixed for the maturity and will not adjust for rising inflation.
Key Catalysts To Watch For When Trading TIPS?
Investors looking to trade TIPS likely need to stay abreast of two main economic indicators: the size of anticipated interest rate hikes and monthly inflation figures.
TIPS are still affected by changes in the Federal funds rate, with duration measuring the move in its price as a function of interest rate changes. The two have an inverse relationship.
For example, if rates are anticipated to increase by 1%, a TIPS with a duration of two years is expected to lose about 2% of its value and vice-versa. Traders looking to immunize from interest rate risk can consider an allocation to shorter maturity TIPS with a lower duration.
The Federal Open Market Committee (FOMC) has reaffirmed its commitment to a series of 50 basis point rate increases throughout its June and July meetings. Policymakers are expected to wait and assess summer inflation figures before deciding on the size of further hikes in September.
Traders can also use TIPS to protect against high, unexpected inflation or short TIPS to hedge against lower-than-expected inflation. This is because the TIPS market has historically been very efficient at pricing in near-term inflation with good accuracy.
The price and yield of TIPS often reflect consensus expectations for a month’s inflation figures in advance before its release. Simply put, a high inflation rate does not always cause TIPS to soar. Inflation must rise faster than anticipated and continue to do so for TIPS to show worth.
Inflation figures such as the monthly consumer price index (CPI) releases and the Personal Consumption Expenditure (PCE) report (the Fed's preferred gauge of inflation) should be observed closely. The next PCE report is scheduled for June 30th, while the next CPI release is scheduled for July 13th.
The latest PCE report showed a 4.9% year-over-year increase for April, compared to a 5.2% increase in March. Although small, this may be evidence that inflation has begun to peak. Investors should pay attention to the market’s consensus for the next release, along with monthly YoY CPI figures.
How To Trade TIPS With Direxion’s ETFs
Investors seeking increased exposure to the TIPS market for speculation or hedging purposes can also consider using Direxion’s suite of Daily TIPS Bull (TIPL) and Bear (TIPD) 2X Shares.
TIPL and TIPD seek daily investment results, before fees and expenses, of 200%, or 200% of the inverse (or opposite), of the performance of the Solactive TIPS ETF Index for a single day. TIPL and TIPD track the performance of the Solactive TIPS ETF Index. Both exchange-traded funds (ETFs) use swaps to add 200% leverage. That means each trade you make yields double the returns — or double the losses in a single day, which is why it’s important to have a clear strategy in place to take profits or cut losses.
Traders with a bullish outlook can buy TIPL to go long if they think TIPS prices will go up. Conversely, traders with a bearish outlook can buy TIPD to go short if they think TIPS prices will drop.
A strategy that employs both ETFs based on technical momentum indicators and trading around economic releases might help investors size their position better, make more efficient use of capital, manage risk more clearly and produce returns in any market condition.
As with all leveraged ETFs, TIPL and TIPD can be a powerful way to magnify short-term exposure, but only if traders do their due diligence on their underlying holdings, have a strong investment thesis and outlook for the TIPS market, and possess a high risk tolerance.
Leveraged and Inverse ETFs pursue daily leveraged investment objectives which means they are riskier than alternatives which do not use leverage. They seek daily goals and should not be expected to track the underlying index over periods longer than one day. They are not suitable for all investors and should be utilized only by sophisticated investors who understand leverage risk and who actively manage their investments.
An investor should carefully consider a Fund’s investment objective, risks, charges, and expenses before investing. A Fund’s prospectus and summary prospectus contain this and other information about the Direxion Shares. To obtain a Fund’s prospectus and summary prospectus call 866-476-7523 or visit our website at direxion.com. A Fund’s prospectus and summary prospectus should be read carefully before investing.
iShares is a registered trademark of BlackRock, Inc. or its subsidiaries (“BlackRock”). Neither BlackRock nor the iShares Funds make any representations regarding the advisability of investing in the Fund.
Direxion Shares Risks – An investment in the Fund involves risk, including the possible loss of principal. The Fund is non-diversified and includes risks associated with the Fund concentrating its investments in a particular industry, sector, or geographic region which can result in increased volatility. The use of derivatives such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. Risks of the Fund include Effects of Compounding and Market Volatility Risk, Leverage Risk, Market Risk, Counterparty Risk, Rebalancing Risk, Intra-Day Investment Risk, Daily Index Correlation Risk, and Other Investment Companies (including ETFs) Risk, and risks specific to inflation-protected U.S. Government securities, including interest rate risk, credit risk, and deflation risk. The value of inflation protected securities, including TIPS, generally will fluctuate in response to changes in “real” interest rates, generally decreasing when real interest rates rise and increasing when real interest rates fall. Real interest rates represent nominal (or stated) interest rates reduced by the expected impact of inflation.
In addition, interest payments on inflation indexed securities will generally vary up or down along with the rate of inflation. Please see the summary and full prospectuses for a more complete description of these and other risks of the Fund.
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