With Wednesday's rate cut, we review volatility in the bond market, as well as the debate between long and short duration bonds
When thinking of the best debates, most people think of Apple vs. Android or Target vs. Walmart, while debates about bonds are usually the last thing on people’s minds. However, fixed income has seen renewed optimism with the Fed cutting rates for the first time this year, making the debate between short and long duration increasingly relevant.
Long-duration bonds are more sensitive to changes in interest rates, making them more prone to sharp movements. Bond volatility has been high since 2020, driven by some of the sharpest hikes and cuts in Fed history. Long-duration treasury fund TLT holds an RRisk of 1.10, meaning it’s exhibited 10% more volatility than the S&P 500 over the last three years. Meanwhile, the iShares Barclays 20+ Year Treasury Bond ETF (TLT) is down 42.9% since the end of 2020 as rates rose from near-zero levels. The market has gained more clarity on the path of interest rates, seeing the market’s gauge of rate volatility hit multi-year lows. The ICE BofA MOVE Index (MLMOVE), or the “Vix for bonds,” measures the expected volatility of treasury rates. The index recently fell below its lowest levels since early 2022. With the bond market finding more stable footing, long-duration bonds could return to their historical norm of lower volatility than equities.
A recent drop in rates has pushed the Long Duration US Treasury group ahead of Short Duration Treasury within DALI. Since the start of September, the Long Duration group has picked up 13 signals while the short duration group has lost 9. The Long Duration group now sits 10 signals above Short Duration. However, there are still some relationships yet to move in favor of long duration bonds.
The total return RS chart between the iShares Barclays Short Treasury Bond ETF (SHV) and TLT has been a reliable indicator of duration preference. Following the RS signals would have doubled the growth of either TLT or SHV including dividends, while a reversal strategy outperforms both funds. While the chart still favors SHV, TLT is close to reversing into Xs, and its 2% chart already reversed in favor of long-duration treasuries. Given the chart’s consistency, it is worth keeping an eye on for confirmation of strength.
While the uptick in long-term treasuries has been notable, it hasn’t only been government bonds moving. Within Asset Class Group Scores, the broader US Long Duration group has a score of 2.68, rising above the 2.55 score of US Short Duration for the first time this year. Long Duration also holds a 1.04 score direction while Short Duration is at negative 0.81, demonstrating that the two groups have been moving in opposite directions.
Broadly speaking, fixed income continues to lack long-term strength, but recent developments do offer some optimism for improvement. Given the presence of bonds in most client portfolios, the battle between long and short duration should be an area to monitor in the coming months, but long duration appears to have taken an initial lead.
