If a Big Bank Is Right, This Bond ETF Could Soon Rally

Fresh services and manufacturing sector data out Wednesday stoked concern that the Federal Reserve may have no choice but to raise interest rates one more time before the end of this year, sending 10-year Treasury yields north of 5% for the first time since 2007. That added chaos in the bond market arrived a week after the Fed unveiled a rate hike of 25 basis points, confirming it will use blunt tools to damp inflation. Put it all together, and these are perilous times for bond investors and an undoubtedly trying environment for leveraged fixed income ETFs such as the Direxion Daily 7-10 Year Treasury Bull 3X Shares (TYD).

In theory, TYD, which seeks daily returns corresponding with 300% of the widely observed ICE U.S. Treasury 7-10 Year Bond Index, may seem like the last bond ETF traders want to consider over the near-term. However, if Treasury yields retreat, this geared Direxion ETF could reward risk-tolerant traders. Some big banks believe declining yields on U.S. government debt are in the cards.

Keep Tabs on TYD No leveraged ETF, including TYD, should be held for weeks or months on end. However, there are reasons why tactical traders may want to monitor this fund going forward. Those include some banks’ expectations that 10-year yields are more likely to retreat to the 4.65% area before the end of this year rather than ascending to the ominous 6% range. “An increasingly asymmetric skew in dual mandate risks means the distribution of potential outcomes has changed, and we think this likely sustains upward pressure on front-end yields even if the Fed doesn’t tighten policy in the near term,” noted HSBC. Assuming 10-year yields decline to 4.65% from current levels, bond prices would of course rise, implying significant upside for TYD.

Obviously, the Fed looms large when it comes to TYD’s near-term fortunes. “Federal Reserve rate cuts pulled short-term bond yields lower last year, but the Fed hiked rates September 16 for the first time in three years and investors expect more to come,” observed Bill Merz , head of capital markets research for U.S. Bank Asset Management Group. He adds, “The combination of changing policy expectations, sticky inflation and stable growth expectations pushed 10-year Treasury yields notably higher so far this year.” High yields could actually be a catalyst for TYD, because bond market history confirms that the higher an investor’s starting yield is, the better their odds are of success. It’s a matter of fixed income investors taking that bait over the near-term.