GOVT: Moving from sale to conservation after collection (BATS: GOVT)

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Thesis

At the end of February, we wrote an article in which we described why we were assigning a To sell rating to iShares Core US Treasury Bond ETF (BATS: GOVERNMENT). In the article we were targeting a price performance of -4%, with 7-year rates expected to test the 3% threshold. 7-year rates have just reached ~2.8%, up nearly 100 bps (1%) since our article. Comprised of US Treasuries and with a duration of 6.98 years, the fund is driven solely by rates. We believe that most of the move in the 7-year yield curve point has already happened, driven by the Fed’s aggressive stance and forward pricing market action.

GOVT is a listed index fund offering an investor exposure to an index composed exclusively of US Treasury bonds, namely the ICE US Treasury Core Bond Index. The composition of the index is rebalanced at the end of each month. The fund currently has a weighted average maturity of 8.44 years and a duration of 6.98 years. The current 30-day SEC yield has risen and now stands at 2.46%.

Given that GOVT has seen its biggest drop in the last decade and that the 7-year yield curve is approaching our target, we believe that this price level is not a good point to maintain a short position. in the fund. So we go from To sell for Hold on the vehicle.

Performance

Since our article the ETF is down more than our target of -4%:

Evaluation

February 2022 Author’s Note (Looking for Alpha)

We did not expect such an aggressive tightening of the market, we expected a faster decline in prices:

author

February 2022 Articles (Author)

Since the start of the year, the fund has seen a massive decline of -8%:

Return of GOVT Awards

Cumulative return since the beginning of the year (Looking for Alpha)

The observed movement is very important for the fund. To put that into context, over the past decade, this is the largest withdrawal on record:

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Prints from the past decade (Portfolio Viewer)

We can see that even in the 2018 cycle, when 7-year rates peaked at just above 3%, the decline was not as large, and the reason for that is how quickly prices market raise Fed rates. The market is now pricing in the sharpest and most aggressive pace of Fed rate hikes since 1994. Runaway inflation driven in part by rising commodity prices and supply chain issues is in part to blame by the feeling that the Fed is behind the curve in fulfilling its inflation-fighting mandate.

Nomura now forecasts several 50 basis point rate hikes this year, with most of the Fed tightening expected to be completed by early 2023:

nomura

Nomura Fed Policy Path (name)

While the front end of the curve may curve reversals we are witnessing tell us to go higher than 3%, as the market thinks mid-rates will lag the front due to expected rate cuts at the end of 2023. Basically, the market doesn’t think the Fed will be able to fight inflation and not negatively affect the economic well-being of the consumer and the labor market. In our view, while the beginning of the yield curve could move higher than what we saw in the 2018 cycle, we believe the midpoint of the curve will follow a similar path to that of 2018.

The 2-10 CMT ratio is the best visualization of this view of the market:

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Report 2-10s (The Fed)

As we can see from the chart, the difference in yield between 2-year treasury bills and 10-year treasury bills is at historic lows.

Assets

The fund is exclusively composed of treasury securities:

Evaluation

Credit ratings (Fund Fact Sheet)

Treasury bills are risk-free given their backing by the US government. As indicated above, the fund is mainly influenced by rates, and more particularly the 7-year point of the curve which corresponds to the duration of the fund:

metric

Metric (Fund Fact Sheet)

Conclusion

GOVT is a Treasury Bond ETF that replicates the ICE US Treasury Core Bond Index. The fund is made up entirely of risk-free securities, so its performance is driven solely by rates. With a duration of 6.98 years, the fund’s movements are determined by the 7-year point of the yield curve. GOVT experienced in 2022 its largest decline in the last decade, measured on a monthly basis. While 7-year rates have just reached ~2.8%, up almost 100 bps (1%) since our article, we believe that this price level is not a good point to maintain a position short in the fund. So we go from To sell for Hold on the vehicle.

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