The United States Treasury issues ‘Treasury bonds’ to fund the governments various departments, pay for programs such as Social Security and maintain a strong military. U.S. Treasury bonds with 10, 20 or 30 year maturities are considered “long” bonds, referring to their long time until their repayment of principal. They are paid by the U.S. Treasury, are backed by the full faith and credit of the United States of America and considered by some to be the most liquid security in the world. They are often “pledged” as high-quality collateral for various typed of loans by financial firms. Nevertheless, you may want to consider an inverse treasury bond ETF as a hedge against our long bonds.
What’s the Concern with U.S. Treasury bonds?
Often considered the safest investment in the world, Standard & Poor’s shocked the financial world in 2012 when it downgraded the credit rating on U.S. Treasury bonds from AAA to AA+. The government countered that there was flawed data used but to no avail. The U.S. government, through the IRS, would always have the ability to tax and there would be no reason for concern over the ability to repay its debt.
Fast forward a few years and the credit situation has arguable gotten worse. Our national debt is over $18 trillion and an economy that will be just starting to test the post-QE, normalized rate waters. The fact that we continue to see our government engaged in ‘debt-ceiling’ countdowns before we run out of money really doesn’t engender much confidence. If this type of behavior and balance sheet was on a private company it probably wouldn’t be AAA rated.
According to the U.S. Treasury Department, in August 2014, roughly 2/3 of our debt was domestically owned and 1/3 foreign owned. The largest domestic owner of U.S. debt is Social Security, at 16% and then there’s the Federal Reserve which owns around $2.5 trillion, triple the level right before the financial crisis.
You may be wondering, who owns our debt? The largest foreign owners of US Treasuries are Japan who just eked out China for the number one spot. Together, these two countries own almost as much as our Social Security. There is the risk that foreign holders of our debt get skittish and look to dump our bonds from concerns over the U.S. credit situation or to raise liquidity for their own problems. China has reportedly starting selling U.S. Treasury bonds to raise cash to prop up its ailing currency, economy and stock market. In addition, other countries can sell U.S. Treasury debt on behalf of another country, such as China or Japan, in cases where these countries don’t want all of their transactions known.
How to Hedge with an Inverse Treasury Bond ETF
There is an inverse Treasury bond ETF (sometimes called short bond ETFs) to hedge exposure to U.S. Treasury bonds. ProShares has the ‘Short 20+ Year Treasury’ ETF, symbol TBF. It aims to deliver the opposite return (-1X) of the Barclays Capital U.S. 20+ Treasury Index. It has almost one billion dollars in assets under management and solid trading volume. ProShares also has a bond inverse ETF for U.S. 7-10 year Treasuries, symbol TBX, which aims to deliver the single inverse of the Barclay’s Capital U.S. 7-10 Year Treasury Index. The difference in maturity between the two Barclays benchmarks (7-10 year vs 20+ years) implies that as interest rates rise, the longer 20+ year bonds should fall more than the 7-10 year bonds because of duration. Therefore, the TBF, which is the inverse of the longer bond benchmark, could perform better than TBX, all else equal.
Barclay’s iPath also offers its ‘U.S. Treasury long-bond Bear inverse ETN, DLBS which is designed to give investors inverse exposure to Barclays Long Bond U.S. Treasury Futures Targeted Exposure Index. This is actually an exchange Traded Note, ETN, not ETF. It is a debt obligation of the issuer and subject to credit risks, similar to the risk of an insurer who has underwritten products.
Finally, hedging longer-term U.S. Treasuries can be a way to control some other liabilities and benefits that could be adversely affected with a severe U.S. long bond sell-off. The U.S. Social Security fund is comprised entirely of U.S. Treasury bonds, as well as the myRA plans. Home mortgage rates loosely follow U.S. 10-year Treasury yields so if you have an adjustable rate mortgage, haven’t locked in a fixed rate or are afraid rates will be too high to ever purchase a home down the road, hedging U.S. long-term bonds is an idea. Note that interest rates tend to move slowly so the holding period for any inverse bond ETFs will be longer than one day for a proper hedge. The longer the holding period for any inverse ETF, the longer the product is likely to stray from its targeted benchmark.
Bond Inverse ETFs mentioned:
- TBF
- TBX
- DLBS