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Bonds and TLT Treasury ETF on the Rebound

After 6 month slide, U.S. Treasury bonds rally on Mideast fears


If you wondered how fleeting popularity can be on Wall Street, just look at how fast U.S. Treasury bonds have gone from hot to not and back again over the past year. Bonds were the go-to investment last summer as the eurozone sovereign debt crisis raged. Between early April and late August, the iShares 20+ Year Treasury Bond (NYSE: TLT) gained nearly 27%.

Things got so out of hand that by September many, including myself, busily warned of a nascent “bond bubble.” Investors had become too pessimistic and weren’t adequately discounting for the risk of higher inflation and improved economic growth. You know what happened next. Bonds got hammered in the months that followed as the Fed pledged to pump $600 billion into the financial system. The TLT lost nearly 18% as a result.

But now, things are reversing once as the rise of popular revolutions throughout North Africa and the Middle East send shockwaves through the energy market. Now, there is concern that higher fuel prices will slow economic growth — a potentially deflationary scenario that favors fixed-income investments. The question is: Can the T-bond rally continue?

It’s worth noting that we’re in the midst of the first substantial uptrend initiation for Treasury bonds since last August. Before that was the big April advance.

tlt treasury etf chart

The chart of the TLT illustrated above is sending some powerful technical signals. Shares of the ETF, which tracks a portfolio of long-term Treasuries, are under heavy accumulation as evidenced by the spike in on balance volume. Shares have moved back over their 40-day moving average, a level that has acted as a key support and resistance level over the past year. And the ADX indicator, a measure of both volatility and trend strength, suggests a powerful upward movement is just getting started.

Fund flows are also supportive of higher T-bond prices. According to EPFR data, global bond funds attracted the most money in over three months during the week ending February 23. This comes in the wake of a multi-month period of fund outflows.

As for the fundamentals, David Rosenberg, chief economist at Canadian money management house Gluskin Sheff, sees deflationary pressures all around. And he believes bond market investors are trading the latest series of protests and unrest in Libya as a “deflationary shock.” If you’re wondering how more expensive oil and food translates into falling prices instead of higher prices, it’s because Wall Street is looking two steps ahead.

It goes something like this: Higher food and fuel prices push up overall inflation, damaging consumer confidence and forcing the Fed to raise interest rates. A drop in spending and the loss of monetary policy support tanks the economy with the job market still in shambles. Demand for goods and housing falls, pushing core inflation lower. Voilà, deflation.

Until something changes, bonds should move higher. But keep in mind, this looks to be merely a temporary reprieve from the long-term bear market in bonds. For more on this, see my Dec. 29 column on the end of the cheap-money era.

Disclosure: Anthony does not own or control a position in any of the companies or funds mentioned.

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