Recent economic data is pointing toward a second wave of recession … and maybe even outright deflation. One key consequence: Long-term interest rates are low and getting lower.
Today I’m going to tell you about some exchange traded funds (ETFs) that I think can thrive in this short-term, falling-rate environment. First, let’s take a look at some evidence the economy is entering the dreaded “double-dip” part of the cycle …
Inflation is staying low. The Consumer Price Index (CPI) — the key gauge of price inflation in the U.S. — is growing at an annualized rate of only about 1 percent. Some of the component prices, like energy, are actually falling.
Moreover, the monthly changes show the deflationary trend is accelerating. June was the third consecutive month that the CPI for All Urban Consumers (CPI-U) actually fell when seasonally adjusted.
When the price of our everyday purchases is flat or falling, it’s very hard for the price of money — which is what “interest rates” are — to rise.
Consumers are losing confidence. The days of carefree trips to the mall and splurging on useless stuff are gone for most Americans. People are overloaded with debt, worried about their jobs, and afraid their savings (if they have any) will evaporate in volatile markets.
This is no doubt a big reason why the University of Michigan Consumer Sentiment Index plunged last month at a rate we haven’t seen since the October 2008 Lehman Brothers collapse, and before that in September 2001.
I’m all for frugality and simple living, but this presents a problem for the retailing industry. They need people to buy things. Increasingly, the only way to motivate consumers is to cut prices to unheard-of levels. This points toward deflation, not inflation.
The housing market is going nowhere. Right now we are in the time of year that has historically been the peak selling season for residential real estate. If they must move, people with children try to do it in the summer.
So when the Mortgage Bankers Association reported that the number of new mortgage applications in the second week of July dropped to its lowest level since December 1996, realtors must have shuddered. People just aren’t buying.
Part of the reason is that the special homebuyer tax credit that recently expired moved a lot of demand forward from summer into spring. Now we have a hangover effect with a humongous supply of homes for sale. This creates serious downward pressure on housing prices.
The Federal Reserve, the banks and the Treasury are well aware of all this. But there isn’t much they can do about it that they haven’t done already; so look for the trends to continue. If anything, we’ll see them try to push mortgage rates even lower to help out the builders and mortgage lenders.
As you can see the big-picture outlook points toward falling interest rates … for the short-term anyway. In fact, it’s already happening.
Since the beginning of April, the ten-year Treasury bond yield plunged from almost 4 percent down to below 3 percent. That’s a huge move in only three-and-a-half months.
Will this trend continue? Hardly …
Runaway government spending is bound to push interest rates higher and bond prices lower as Washington scrambles to cover all the new debt. And when you pile on the commitments made to fund Social Security and Medicare, it’s easy to see why interest rates are almost guaranteed to go up soon.
But what we’re experiencing right now with rates falling could still be a great short-term opportunity. But where?
ETFs for Falling Rates
Individual bond trading is tough to do in small amounts, and most bond mutual funds are designed for income, not speculation.
However, bond ETFs could be the ideal vehicle if you just want to bet on a short-term price trend like this one. Bond prices rise as interest rates fall, and the impact is magnified in long-term bonds.
Here are three bond ETFs that are well-known, easily tradable and sensitive to changes in long-term interest rates. Therefore, they give you the flexibility to get out quickly when yields start to shoot back up and bond prices plummet, which they indeed will. And once bonds have sold off, you can jump back in again:
- iShares Barclays 20+ Year Treasury Bond ETF (TLT). This one is about as simple as they get. It’s a plain-vanilla bond fund that holds U.S. Treasury securities with a maturity of 20 years or longer.
- Vanguard Extended Duration Treasury ETF (EDV). This is a “zero coupon” bond fund, which means there are no interest payments. With no coupon, the moves in the underlying bond prices are more exaggerated than with traditional coupon-paying Treasury bonds. EDV is a pure bet on falling Treasury rates.
- Direxion Daily 30 Year Treasury Bull 3X Shares (TMF). Hold on to your hat! This ETF tries to triple the daily change in the price of 30-year Treasury bonds. Needless to say, you should expect a wild ride and your timing has to be near-perfect. But if you can handle the risk, TMF is a way to maximize your exposure to falling Treasury yields.
Treasury rates have fallen a long way in the last few months, and a correction could unfold at any time. Even so, I think this is a case for making the trend your friend.
P.S. I just put the finishing touches on my ETF Field Guide. See why this is the one report Wall Street’s fund managers don’t want you to read.
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