Why hasn't my bond ETF made money when interest rates are pushing bond prices up?

US Treasury Secretary Scott Bessent (Scott Bessent) recently reiterated his view that the yield on 10-year bonds under the leadership of the Trump administration will decline. Since the Federal Reserve initiated a cycle of interest rate cuts in September last year, how has the bond market performed? Everyone says that interest rate cuts will push bond prices up, so why hasn't my bond ETF made money?

Bostic: Government focuses on the 10-year Treasury yield, not Fed rate cuts

US Treasury Secretary Mnuchin, Scott Bessent (Scott Bessent) said in an interview with Fox Business on Wednesday that the Trump administration's focus on lowering borrowing costs is the 10-year Treasury yield, not the Fed's benchmark short-term interest rate. He emphasized that he and President Trump are concerned about the 10-year Treasury bond, and Trump did not call on the Fed to cut interest rates.

He reiterated his view that under the leadership of the Trump administration, the yield on 10-year Treasury bonds will decline. Bessent said that Musk's government efficiency team did not manipulate the payment system of the Treasury Department and emphasized that their work will bring substantial savings.

Bernstein reiterated his view: expanding energy supply will help reduce inflation. He said that for the American working class, 'energy components are one of the most reliable indicators of long-term inflation expectations'.

Benson said, "If we can bring down the prices of gasoline and natural gas, these consumers will not only save money, but their optimistic sentiment towards the future will also help them get rid of the high inflation in recent years."

The Importance of 10-Year Treasury Bonds

Although the short-term benchmark of the Federal Reserve is an important reference for the money market, the 10-year Treasury yield also serves as a benchmark for 30-year mortgage rates and other key lending rates.

If the Federal Reserve lowers the benchmark interest rate, but the yield on the 10-year Treasury bond remains high due to other factors, it will impose a huge burden on corporate borrowing and individual home purchases. In the long run, it will also drag down the performance of the stock market.

In the figure below, we have marked the three interest rate cuts by the Federal Reserve starting in September last year with purple arrows. It can be seen that the bond market actually reflected expectations half a year before the start of the interest rate cutting cycle. After six months of ups and downs, the yield on 10-year US bonds remained high at 4.446%, a decrease of only 0.554% compared to the high point of 5% in October 2023, during which time the Federal Reserve has lowered the federal benchmark interest rate by 1%. It can be seen that the yield on 10-year government bonds does not move in lockstep with the Fed's benchmark interest rate.

Original data source: CNBC What are the factors that affect long-term bonds?

The yield on the 10-year Treasury bond is an important market indicator, which is affected by various factors in addition to the Federal Reserve's benchmark interest rate. For example, inflation expectations - the higher the inflation rate, the higher the yield investors will demand to offset the losses caused by inflation. Market demand and supply also play a role - when investors' demand for bonds increases, the yield will rise; when the supply increases, the yield will decrease, which is closely related to the U.S. Treasury's debt issuance plans.

Interest rate cuts drive bond prices up, investors seeking to earn "capital gains"

Many investors like the fixed income of bonds. Compared to the volatility and high uncertainty of the stock market, they take advantage of the high US interest rates and buy bonds while the rate-cut cycle is initiated. This allows them to lock in high interest rates and also have the opportunity to enjoy the "capital gains" from the rising bond prices during the rate-cutting period.

However, the previous surge in US Treasury bond yields also temporarily caused panic among investors and led to market turbulence. Vice President-elect JD Vance expressed concerns that if bond yields continue to rise, he worries that US bonds may face a 'death spiral'.

(Global funds continue to buy US bonds. Should we be worried about the death spiral?)

Although buying government bonds directly and holding them until maturity can lock in the interest rate, as long as you hold them for a long time, you will not lose money. I believe that many financial professionals are actively promoting this to retail investors. However, as can be seen from the ten-year yield chart above, not all investors who entered the market last year are currently making money. Moreover, the threshold for buying government bonds is very high, with a basic transaction starting at ten million US dollars among banks. Although Taiwanese banks have introduced channels for entering the market with as little as ten thousand US dollars, it can be seen that there must be a lot of discount space in the price and market.

Not buying bonds, buying bond ETFs instead?

Due to the high threshold for buying bonds, most retail investors will choose to use bond ETFs instead, such as BlackRock's iShares 7-10 Year Treasury Bond ETF (IEF), which invests in 7-10 year bonds issued by the U.S. government and tracks the index ICE U.S. Treasury 7-10 Year Bond Index。

The current quote for IEF is 93.42, one share is 93.42 US dollars, which is equivalent to about 3,000 Taiwanese dollars to buy bond assets, which is a more friendly investment product for retail investors.

However, the bond ETF holds a basket of government bonds, which must be held until the maturity date within the specified period. Therefore, bonds cannot be held until maturity, and must be gradually sold off to establish positions in longer-term bonds.

If you had invested $10,000 starting from the year 2015, after ten years you would only receive $10,590, with an annualized return rate of only 0.57%. In contrast, the yield on 10-year US Treasury bonds issued in February 2015 was approximately 2%.

Why is my bond ETF still losing money?

Taking the E Fund Taiwan Dollar Bond Fund, which is more familiar to Taiwanese investors, as an example, 00679B is the largest US dollar bond ETF in the Taiwan market, with a fund size of up to 310.8 billion NTD. It is currently quoted at 29.2 NTD, and buying one share requires only 29,200 NTD, which is much lower than the threshold for directly buying bonds. Compared with the asset size of the largest and oldest ETF in Taiwan, the Yuanta Taiwan 50 ETF (0050), which is at 457.4 billion NTD, it can also be seen that Taiwanese investors love US dollar bond ETFs.

But bond ETFs hold a basket of government bonds and do not hold them until maturity. Taking 00679B as an example, it tracks the ICE US Treasury 20+ Year Bond Index. Currently, the bond with the shortest maturity date is 912810RK6 (US TREASURY N/B 2.5% 02/15/2045), with a remaining weight of only 0.09%, because it is close to its maturity date of 20 years, so it must be gradually sold and positions in longer-term bonds established. The bond with the longest tenure is 912810UA4 (US TREASURY N/B 4.625% 05/15/2054), with a remaining tenure of 29 years and a weight of 5.14%.

This also means that bond ETFs must achieve the standard of tracking the index through continuous buying and selling, without the concept of "held-to-maturity". A basket of bonds will always be maintained within the specified "term". Also, 00679B is denominated in New Taiwan Dollar, with exchange rate hedging costs, so its five-year return is -22.26%, three-year return is -18.13%, and one-year return is 1.49%.

Data Source: MoneyDJ

This article Why didn't my bond ETF make money when interest rates fell, which was first published in Chain News ABMedia.