Dreams of a big win in bonds backfired with an ETF loss of $10 billion.

Oct 13
Wall Street professionals have invested unprecedented sums of money in the largest Treasury ETF in the world this year, confidently believing that interest rates have peaked. Investors have been incorrect all year and have lost $10 billion as a result, but they are continuing to invest despite the greatest market decline in decades.

The fundamental justification is that even a slight improvement in long-term public debt would result in substantial gains.
The $39 billion iShares 20+ Year Treasury Bond ETF (ticker TLT) has drawn a record $17.6 billion this year despite indications that inflation pressures are still there, as highlighted by Thursday's statistics. Among the more than 3,300 ETFs listed in the US, this has the third-highest volume.

Demand increased as the fund's loss widened, and Thursday's trading revealed the full depth of the decline. A lackluster auction of the 30-year Treasury note added to the market's troubles. Even after a small recovery earlier this week as the Middle East turmoil increased demand for shelters, TLT is still around 50% below its peak from 2020.

When you consider some simple investment mathematics, the bullish appetite makes sense. The 20-year Treasury yield is currently hanging around 5%, so according to F/m Investments, a decline of 50 basis points would result in a total return of more than 11% over the following 12 months, while an increase of 50 basis points would only cause a loss of around 1.1%.

The longer tenure of long bonds—a measure of a security's sensitivity to interest rate changes—will serve as a larger source of gains, even if the entire Treasury curve will benefit from lower yields.

Short-term debt does not have a very high potential return. Given how high yields are currently, a 50 basis point increase would still result in a yield of about 4.6%, with 2-year rates hovering around 5.07%. If interest rates were decreased by 50 basis points, that gain would increase to 5.5%.

In addition to inflows into the fund, the options market is also experiencing rising optimism. Compared to bearish puts, TLT's open interest in call contracts is almost at a 20-year high, according to Bloomberg.

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