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ETF Bond Trade: How The End Of Quantitative Easing Will Affect Bond Prices

February 7th, 2013

market bondsJeff Uscher: Equities rallied and bond prices fell through January as investors, relieved that Congress had avoided the fiscal cliff and postponed a fight over the debt ceiling, changed their stance to take on more risk.

With the immediate crisis over, the need for safe-haven instruments such as U.S. Treasury bonds has diminished, sending yield-starved investors scrambling for better returns.

Improving sentiment in the United States, Europe and even in Japan has sent U.S. Treasury bond prices lower. The yield on the 10-year Treasury bond is now over 2.0% for the first time since April of last year, having averaged 1.80% for 2012.


But it’s not just improved sentiment that’s going to push down bond prices.

How the End of QE Will Affect Bond Prices

U.S. Federal Reserve’s quantitative easing (QE) policy has made a conservative buy-and-hold strategy in U.S. Treasury bonds very risky.

So risky, in fact, that a recent report by Charlie Gasparino of FOX Business Network states that UBS is planning to send a letter to its brokerage clients telling them that they have been reclassified as “aggressive” investors.

The letter, which is said to be controversial within the firm, is thought to reflect UBS’s long-term bearishness on bonds.

In the meantime, conservative bond investors willing to sacrifice yield for the preservation of capital will suddenly find themselves classified in the same group as wild-eyed penny stock speculators and options cowboys. It is thought that UBS is reclassifying its customers to avoid future legal action when the bond market falls.

Even PIMCO’s Bill Gross thinks the end of QE will pose major problems for the bond market. In his February briefing, Gross writes that the continual expansion of credit by the Fed and other central banks results in less and less real GDP growth.

“In the 1980s, it took four dollars of new credit to generate $1 of real GDP,” Gross stated. “Over the last decade, it has taken $10, and since 2006, $20 to produce the same result.”

The Fed has been up front about the conditions that need to be met for it to end quantitative easing but has been less open about how it plans to carry out the policy shift.

This has raised concerns not only among investors but, according to a report by noted Fed watcher Stephen Beckner writing for Market News International, among Fed officials themselves.

“Instead of raising short-term interest rates once economic recovery has been convincingly established and unemployment is falling, the FOMC has explicitly said it will delay hiking the federal funds rate “for a considerable time after the asset purchase program ends and the economic recovery strengthens,’” Beckner writes.

“Together, the Fed’s open-ended, “flexible” asset purchases to hold down long-term rates and its plan to hold short-term rates down much longer make for an unprecedented experiment in monetary expansionism,” Beckner continued. “When the phase-out of QE3 begins, bond yields and rates all along the maturity spectrum are sure to rise, even though the FOMC vows it will continue to hold the funds rate near zero for quite some time.”

How to Profit from Lower Bond Prices

However you look at it, with the end of QE looming, U.S. Treasury bonds are not the safe haven they once were and investors should be prepared for that.

There are a number of ETFs that trade inversely to bond yields that could provide a hedge to an existing bond portfolio or an opportunity to profit from a decline in bond prices.

Some of the more liquid alternatives include the ProShares Short 7-10-Year Treasury ETF (NYSEARCA:TBX), which trades inversely to the 7-year to 10-year U.S. Treasury bond market. Further out on the yield curve is the ProShares Short 20+ Year Treasury ETF (NYSEARCA:TBT), which trades inversely to the 20-year to 30-year U.S. Treasury bond market.

Investors can find a leveraged way to short U.S. Treasury bonds with the Direxion Daily 20+ Year Treasury Bear 3x ETF (NYSEARCA:TMV).

Related Tickers: iShares Barclays 7-10 Year Treasury Bond Fund (NYSEARCA:IEF), ProShares Short 20+ Year Treasury ETF (NYSEARCA:TBF), iShares Barclays 20+ Year Treas Bond ETF (NYSEARCA:TLT), Barclays 1-3 Year Treasury Bond ETF (NYSEARCA:SHY), PIMCO ETF Trust (NYSEARCA:BOND).

Money MorningWritten By Jeff Uscher For Money Morning

We’re in the midst of the greatest investing boom in almost 60 years. And rest assured – this boom is not about to end anytime soon. You see, the flattening of the world continues to spawn new markets worth trillions of dollars; new customers that measure in the billions; an insatiable global demand for basic resources that’s growing exponentially; and a technological revolution even in the most distant markets on the planet.And Money Morning is here to help investors profit handsomely on this seismic shift in the global economy. In fact, we believe this is where the only real fortunes will be made in the months and years to come.


NYSE:SHY, NYSE:TBT, NYSE:TBX, NYSE:TLT, NYSE:TMV


 

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  1. Ashish.Mehta
    May 24th, 2013 at 14:59 | #1

    This article describes the circumstances of and motivations for the quantitative easing programs of the Federal Reserve, Bank of England,
    European Central Bank and Bank of Japan during the recent financial crises and recovery.
    Central bank has two weapons to stimulate the economy. One is conventional tool and other is non conventional tool. In conventional tool central bank control short term nominal interest rate that can potentially affect economy through variety of channels (i.e. change in real interest rate influence level of output and employment).
    When nominal interest rate near to zero and here is no room maneuver for further rates cut then central bank using non conventional tool (i.e. quantative easing ,credit easing)which we see right know.) Quantative easing first applied by Bank of Japan in 1999 and then after 2007-09 financial crises in U.S, U.K, BOJ& European Union. In quantatve easing central bank purchase long term govt. bonds to stimulate the economy. The focus of policy is the quantity of bank reserves, which are liabilities
    Of the central bank; the composition of loans and securities on the asset side of the central
    Bank’s balance sheet is incidental”. And in credit easing polices it intend to reduce the interest rate .In this polices central bank buy govt. bonds, corporate bonds, mortgage bonds, etc.
    After 2007-08, central banks expand their balance sheet aggressively to stimulate their economy, reducing unemployment, and get anchor inflation in there economy .At present known of advance economy that use aggressively easing policies succeed. Neither their economies come back on track nor does their employment level reduce. Everything from quantative easing to zero policy rate is tried to support job income, jobs and production. On the other hand a lot of liquidity is not creating credit for real economy it is going into assets price inflation and adding leverage in financial system. If growth remain weak and more easing policy by central bank then this liquidity searching for higher yields might enter in equities specially emerging countries .higher liquidity creates asset price inflation . Once central bank tight or increase their rates the we see correction in equities and again bubble have been burst because of downside risk to global economy growth and if downside economic growth materialize in spite of liquidity then we see correction in equity market. In 2010 Fed take a second round of quantative easing and what is the impact of QE 2 that most of liquidity entering in emerging economics (i.e. in equity) and commodity creates high inflation in emerging economies who will benefit for cheap liquidity only high net worth peoples because they borrow money from cheaper rate and invest in emerging economies. Know central banks have last chance to go for this non conventional tool polices to stimulate the economies. Over time, they also focus on fiscal consolidation because debt is very high and eventually unsustainable. They also do some structural reform to liberalize the economy and further trade liberalization to increase potential growth.

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