Stay Informed and Stay Ahead: Guidance, August 19th, 2024
Strategic Investment Adjustments
In volatile markets, investors often over-rely on news, media, and earnings reports, or solely depend on advisors. This article offers practical advice to help all types of investors navigate these uncertainties with sound strategies executed at the strategic level with high-level fund managers to secure and grow capital effectively.
Key Takeaway
Long-Duration Bonds: Focus on long-duration bonds, which benefit from rate cuts due to their inverse relationship with interest rates. Historically, a 1% rate cut can increase long-duration bond prices by 14-26%. As the Fed eases rates, their value rises since fixed payments become more attractive compared to new, lower-rate bonds.
Illustrating ETF TLT in Relation to the Fed Funds Rate
The iShares 20+ Year Treasury Bond ETF (TLT) tracks long-duration U.S. Treasury bonds. Its performance is closely tied to changes in the Fed Funds Rate due to its sensitivity to interest rate fluctuations.
Relationship Overview:
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Inverse Relationship: TLT generally exhibits an inverse relationship with the Fed Funds Rate. When the Fed raises rates, long-term bond prices, including those in TLT, typically fall because new bonds are issued with higher yields, making existing bonds with lower yields less attractive.
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Rate Cuts Impact: Conversely, when the Fed cuts rates, TLT tends to rise. Lower interest rates increase the value of existing bonds with higher fixed coupons since new bonds are issued at lower rates. Historically, a 1% rate cut can increase TLT’s price by approximately 14-18%.
Illustrating ETFs EDV and ZROZ in Relation to Fed Rate Cuts:
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Duration Sensitivity: EDV (Vanguard Extended Duration Treasury ETF) and ZROZ (PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF) have even higher durations, around 25-27 years, compared to TLT’s 17-18 years. This makes them more sensitive to interest rate changes.
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Price Increase Estimate: A rough estimate for a 0.5% rate cut shows that EDV and ZROZ might see a price increase of approximately 12.5% – 13.5%, significantly higher than TLT’s 8.5% – 9% increase, given their longer durations.
Summary: Understanding these relationships helps investors gauge the potential performance of TLT, EDV, and ZROZ based on anticipated changes in the Fed Funds Rate. When the Fed cuts rates, long-duration Treasury ETFs generally rise, with EDV and ZROZ likely experiencing more substantial gains compared to TLT due to their higher duration.
