2023-12-08 11:40:29 ET
Summary
- TBF may be useful as CPI data comes out next week which we expect to stoke fears of the stickiness of inflation.
- Leveraged ETFs have daily resetting returns and should be used over short durations due to value erosion and volatility drift.
- Moreover, TBF is sensitive to rate changes due to high duration. We are more confident in the longer-term realisation of markets than the shorter term in inflation's stickiness.
- Unemployment data ticking lower also reaffirms the possibility that CPI might disappoint next week, building the case for TBF.
- However, the features of the instrument, and the lack of careful consideration of the markets would have us looking at something less sensitive.
The ProShares Short 20+ Year Treasury ( TBF ) is an ETF, in the family of leveraged ETFs with daily resetting returns. These types of ETFs do not lend themselves to long holding periods due to the many issues associated with the dynamics of daily resetting. We think that TBF could be useful into next week as CPI data comes out on Tuesday, especially since the market seems to be alright with the lower unemployment which we view negatively and likely to confirm the stickiness of inflation and the need for a recession. We think there is a speculative case for believing that the soft landing excitement is premature, and the CPI data may confirm that the link between somewhat softening jobs data and the CPI might not be there. However, TBF is sensitive due to higher duration, and these multivariate issues make us cautious about an instrument that may have holders hoping for a longer-term resolution by markets if they don't react as expected to incoming data.
On TBF
0.9% is the expense ratio for TBF . It's not a lot, and in general, these ETFs are a good way to get access to leverage in cases where access to leverage may otherwise be limited.
However, these leveraged ETFs reset on a daily basis, which introduces behavior such as value erosion, volatility drift, and other dynamics. If you don't fully understand these risks, you may not want to proceed with a leveraged ETF. They are best used over short durations because of value erosion. They are highly speculative and volatile instruments. Be careful.
Links for reference on these risks:
- The Lowdown on Leveraged and Inverse Exchange-Traded Products
- Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors
- Regulatory Notice 09-31 | FINRA.org
TBF is exposed to short positions of a reference portfolio of US Treasuries of different maturities above 20 years, for example maturities due for 2045, 2046 and so forth. The effective duration of the portfolio is around 17 years, the reason being that the distant maturities are so discounted that they basically are vanished.
Nonetheless, the relationship is still that of high sensitivity to a change in rates. Duration measures the differential in price from a tiny change in rates. Naturally, as rates change, so does duration, because duration is calculated as a weighted average of discounted cash flows. Rates are a factor of the duration calculation, which in turn is a factor of the price differential, which also separately has a factor of the rates. So duration measures the impacts of a tiny movement on prices from rates, and then needs to be recalculated to see what the next tiny step does to prices. But coarsely speaking, you can say that the duration estimates the factor of a unit change in rates on the percentage price change of the related bonds. 17-18 year duration means very serious sensitivity to rate changes, which makes TBF useful as a speculative instrument.
Bottom Line
While daily resetting can be an issue over longer periods, we think the key data to follow right now is the CPI data coming out on Tuesday.
Until now, labour market data has been a primary focus, as it has been seen as a leading indicator for the persistent and core part of inflation. This is sensible and pays attention to the wage-price spiral and how it drives expectations and anchored levels of baseline inflation. Today we got employment data, which is also important, since we should assume that the Phillips Curve dynamics are now back in action. Unemployment is actually down, which is a little bit contrary to what might have been initially suggested with JOLTS data.
We think that markets are generally underestimating how sticky inflation might be, or how quickly we'll see further steps on this last leg of inflation without a recession happening. Falling unemployment rates just means that there is more time for expectations to anchor at higher rates, and that you need unemployment to really get the effect of reduced inflation or breaking the back of a newly forming inflation anchor. Falling unemployment is also evidence that the traditional drivers of lower inflation are not coming into effect yet.
This means that CPI data next week may disappoint markets by being at higher than expected levels, and make them realise that higher for longer is what needs to happen, and all those rate cuts priced in for 2024 are premature. In this setting, TBF is interesting. Phillips Curve logic has shown to be effective once the speculative frenzies have been crushed by more conservative savings practices such as good old deposits. The lower unemployment is really not a great thing, and just keeps the inflation wheel turning with an increasingly anchored expectation of 3%, as market actors continue to flex pricing, even the more marginal ones after the big consumer players.
However, it is a sensitive instrument, and commodity deflation is continuing. While we worry about the core inflation wheel still turning with ample velocity, whether markets want to acknowledge the dangers of their optimistically priced equilibriums will remain to be seen, and TBF may not payoff as expected.
While TBF's exact behaviour next week will be unclear, we are sure that lower unemployment, especially paired with growing inflation expectations , means that a recession will be required to tackle the anchoring inflation rates.
For further details see:
TBF: Unemployment Down, Inflation Will Look Sticky On Tuesday