US Treasury Secretary Scott Bessent recently reiterated his view that 10-year Treasury yields will decline under the Trump administration. How has the bond market performed since the Federal Reserve started its rate cut cycle last September? Everyone says rate cuts will drive bond prices higher, so why isn't my bond ETF making money?
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ToggleBessent: The government is focused on 10-year Treasury yields, not the Fed's rate cuts
In an interview with Fox Business on Wednesday, US Treasury Secretary Scott Bessent stated that the Trump administration's focus on lowering borrowing costs is on the 10-year Treasury yield, not the Federal Reserve's benchmark short-term interest rate. He emphasized that he and President Trump are focused on the 10-year Treasury, and Trump has not called for the Fed to cut rates.
Bessent reiterated his view that 10-year Treasury yields will decline under the Trump administration. Bessent said the government efficiency team led by Musk has not manipulated the Treasury's payment systems, and their work will bring significant savings.
Bessent reiterated his view that expanding energy supply will help reduce inflation. He said that for the American working class, "energy components are one of the most reliable indicators of long-term inflation expectations."
Bessent said: "If we can get gasoline and natural gas prices down, not only will those consumers save money, but their optimism about the future will also help them shake off the high inflation of recent years."
The importance of the 10-year Treasury
While the Fed's short-term benchmark is an important reference for the money market, the 10-year Treasury yield is also a benchmark for 30-year mortgage rates and other key borrowing rates.
If the Fed lowers its benchmark rate, but the 10-year Treasury yield remains elevated due to other factors, it will impose a heavy burden on corporate borrowing and personal home purchases. In the long run, it will also weigh on stock market performance.
In the chart below, we have marked the three rate cuts by the Fed since last September with purple arrows. We can see that the bond market had already started reflecting the expectations even half a year before the rate cut cycle began, and after half a year of ups and downs, the 10-year Treasury yield is still holding at a high level of 4.446%, only down 0.554% from the October 2023 high of 5%, while the Fed has lowered the federal funds rate by 1% during this period. This shows that the 10-year Treasury yield and the Fed's benchmark rate are not closely correlated.
What factors affect long-term Treasury yields?
The 10-year US Treasury is an important market indicator, and it is influenced by factors beyond just the Fed's benchmark rate. For example, inflation expectations - the higher the inflation rate, the higher the yield investors will demand to offset the loss from inflation. Or market supply and demand - when investor demand for Treasuries increases, yields rise; when supply increases, yields fall, which is closely related to the Treasury Department's borrowing plans.
Rate cuts drive bond prices higher, investors want to earn "capital gains"
Many investors like the fixed income of bonds, compared to the volatility and high uncertainty of the stock market. Taking advantage of the still-high US interest rates, and entering the bond market as the rate cut cycle begins, not only can they lock in high yields, but they also have the opportunity to enjoy "capital gains" from the rise in bond prices as rates are cut.
However, the recent surge in US Treasury yields has also caused panic among investors, leading to financial market turmoil. The incoming Vice President, JD Vance, has previously stated that if bond yields continue to rise, he is concerned that US Treasuries could face a "death spiral".
(With global funds continuing to buy US Treasuries, should we be worried about a death spiral?)
Although directly buying government bonds and holding them to maturity can lock in the interest rate, and as long as you hold them until maturity, you won't lose money, many financial advisors also actively promote this to retail investors. However, the 10-year yield chart shows that not all investors who entered the market last year are currently making money, and the threshold for buying government bonds is quite high, with the basic transaction in the interbank market starting from $10 million, although Taiwanese banks have now introduced a channel where you can enter the market with as little as $10,000, the price is likely to have a significant discount compared to what the market sees.
Instead of buying bonds, what about buying bond ETFs?
Since the threshold for buying bonds is quite high, most retail investors choose to invest in bond ETFs instead. Taking the iShares 7-10 Year Treasury Bond ETF (IEF) issued by BlackRock as an example, this ETF invests in 7-10 year US government bonds and tracks the ICE U.S. Treasury 7-10 Year Bond Index.
The current quote for IEF is $93.42, which means you can buy the bond assets for around NT$3,000, making it a more investor-friendly investment product for retail investors.
However, bond ETFs hold a basket of government bonds and need to maintain the bond maturity within the specified period, so the bonds cannot be held to maturity, but must be gradually sold and longer-term bond positions established.
If you had invested $10,000 starting in 2015, after 10 years you would only be able to recover $10,590, with an annualized return of only 0.57%. The yield on 10-year US Treasuries issued in February 2015 was around 2%.
Why is my bond ETF still losing money?
Let's take the example of the Yuanta US Bond 20Y ETF (00679B), which is the largest US bond ETF in the Taiwanese market with a fund size of NT$310.8 billion. The current price is NT$29.2, and you only need NT$29,200 to buy one unit, which is much lower than the threshold for directly buying bonds. Compared to the Yuanta Taiwan 50 ETF (0050), which is the largest and oldest ETF in Taiwan with an asset size of NT$457.4 billion, it can also be seen that Taiwanese investors have a strong preference for US bond ETFs.
However, bond ETFs hold a basket of government bonds and do not hold them to maturity. Taking 00679B as an example, it tracks the ICE US Treasury 20+ Year Bond Index. The bond with the shortest maturity currently held is 912810RK6 (US TREASURY N/B 2.5% 02/15/2045), with a weight of only 0.09%, because it is already close to its maturity date of 20 years, so it must be gradually sold and longer-term bond positions established. The bond with the longest maturity is 912810UA4 (US TREASURY N/B 4.625% 05/15/2054), with 29 years until maturity and a weight of 5.14%.
This means that bond ETFs must constantly buy and sell to track the index standard, without the "hold to maturity" option, and the basket of bonds will always be maintained within the specified "term". Additionally, 00679B is priced in TWD, so there is also a currency hedging cost, which is why its 5-year return is -22.26%, 3-year is -18.13%, and 1-year is 1.49%.
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