Shorting America, the Debt

Whether you believe it is part of healthy growth or increased inflation, long term nominal interest rates are rising and expected to continue higher.  There are several ways to play this increase in long term interest rates. You could sell the 30 Year US Treasury Bond Futures contract, buy the Proshares Ultrashort Lehman 20 ETF, TBT, or short the iShares Barclays 20+ Year Treasury ETF, TLT, or play options on these underlyings.   Which way is best?  The Futures are very tightly correlated to 30 year Treasury cash rates, but one contract gives exposure to about $120,000 of notional today at about 50:1 leverage.  You had better know what you are doing playing that contract and have some deep pockets.  So what about the ETF’s, which is better?  The answer is that it depends on your horizon and risk tolerance. Let’s figure it out using some simple charts.

Seeking Correlation

The cluttered chart below simply shows the performance of 30 year Treasury yields, inverted price of the TLT, and the straight price of TBT, in the top three panels and a ratio of the TBT to TLT price in the bottom panel.

The top 3 panels clearly show that both the TLT and TBT are highly correlated to 30 year Treasury yields. They all have the same general shape. It is the fourth graph that gives some useful information to distinguish between the two ETF’s. If TBT and TLT were equally correlated to 30 year Treasury yields then this ratio should be near constant, but it is far from it. What is going on?

Determining Best Correlation

Now look at the two charts below, showing the relative performance year to date of each ETF versus the 30 year Treasury yield. First observe the chart for TLT.

This chart shows the straight price performance of the TLT to 30 year Treasury yields. Notice that the symmetry from the picture above is now the mirror image. But more importantly note that both lines have the same displacement from the zero line throughout the year and where yields have seen a fall off and now a rise to where they are about 5% below the start of the year, TLT is close at about a 7% gain year to date. Now look at the chart of TNT versus 30 year Treasury yields below.

Since TBT is an inverse ETF, the shapes remain similar. It has a greater range, as expected given that it s a 2x levered ETF. But the result year to date is quite unexpected. Where 30 year Treasury yields are off 5%, the TBT is off about 24%, not the 10% expected.

Which to Choose

The math that leads to this difference is for another article to deal with. The point to take away, very simply from looking at charts, is that the correlation is not as tight between the TBT and 30 year Treasury yields as it is between TLT short and 30 year Treasury yields. If you are looking to hedge 30 year Treasury interest rate risk or make a long term bet against Treasuries then you should be using TLT over TBT. If you are looking to hedge or bet on a short term basis and able to absorb some downside risk that then the higher beta of TBT might be for you.

Trade well.

(As always you can see details of these individual charts and more on my twitter feed and on chartly.)

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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