TLT Appears To Be Breaking Out (NASDAQ:TLT)

Bonds have made a decent recovery since late April. The outlook is improving as “higher for longer” rates don’t look as likely as they once did, but many will be nervous about this rally and bonds remain at lower highs for the year. As this article will illustrate, I think this is the time to buy as it could just be the start of a big rally. The iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) has broken out and could be on its way above $100.

The Breakout

There are a number of fundamental reasons to be bullish on bonds at the moment, and I will cover these later, but it is always important to check what the market is doing to see if it agrees with your thesis. This can be achieved through technical analysis and I argued back on May 21 that TLT was about to break out and take its leveraged cousin, the Direxion Daily 20+ Year Treasury Bull 3X Shares ETF (TMF) with it. The chart below is from that article, TMF: Leveraging A Potential Break-Out.

TMF broke the downtrend soon after. The TLT chart now looks like this –

We can see prices rallied above the red downtrend line in early June, and then re-tested the breakout point before continuing strongly higher. This was textbook price action, and it suggests TLT has broken its downtrend which started in late December 2023. The next phase of the rally should eventually exceed the December 2023 peak and if we get a proportional rally to the Q4’23 rally, it should target at least $105.

More bullish evidence comes from the TLT chart’s moving averages. TLT is above all the daily averages and the majority of the weekly ones too.

Driving the Rally

Hot data in Q1 encouraged the “higher for longer” view on rates, but was a swing too far to the hawkish side. 2023 followed a similar theme with hot data in Q1 that soon slowed, and we are seeing the same happen again. The labor market is clearly cooling, while economic indicators such as PMI, retail sales and other metrics are suggesting higher rates may finally be having an effect. It’s not yet time to talk about a recession, but a slowdown means “higher for longer” can finally be put to rest and that will be a massive boost for long duration bond ETFs such as TLT.

Another boost comes from the Fed’s resolutely dovish stance. Q1 data did not get them to shift at all hawkish, and they seem to be itching to cut if only the inflation data will allow it. In light of last week’s CPI, that now looks much more likely, and it would only take one or two more soft readings to give them the green light.

Even if inflation stays sticky, there are other routes to cuts. Powell has mentioned the labor market twice now in this context and said a “meaningful” rise in unemployment could get the fed to cut early. Granted, June’s rise in unemployment to 4.0% will hardly inspire panicked cuts, but this was the highest rate since January 2022, and it is inching steadily up from the 3.4% low. Furthermore, the weekly Unemployment Claims numbers are mildly concerning. Last week’s 242k reading is the second figure near the red flag level of 250k.

I think bonds are breaking out on the recognition that the economy is slowing, and the Fed is getting close to cuts. I also think the Fed may cut more than the one cut the last dot plots projected. The last meeting in early June actually had some hawkish elements, such as a higher projected neutral rate. However, we already know how quickly this can change, and a cut in September could be followed by two more this year should the conditions worsen. This would be the perfect backdrop for a TLT rally.

Why TLT?

TLT “invests in U.S. dollar denominated fixed rate U.S. treasury securities with remaining maturity of greater than or equal to twenty years.” (iShares)

At the moment, the 20Y bonds have a slightly higher yield than the 10Y and 30Y either side of it.

TLT pays a dividend of 3.41% (TTM), which is hardly amazing, but beats the iShares 7-10 Year Treasury Bond ETF (IEF) which yields only 2.92%. In any case, the yield is only one part of TLT’s attraction. As it has a high duration of nearly 17 years, it is very sensitive to changes in interest rates.

It would only take a drop of around -0.5% in 20Y yields for TLT to rally 8% and make it back to the December ’23 high around the $100 level. A break of $100 would target $105, even the 2023 high of $109.

Risks

TLT is very sensitive to interest rates and should there be a sustained second inflationary wave for any reason, TLT would likely drop below the 2023 low of $82.42.

There is a risk that the current break-out is not as strong as projected, but if TLT stalls and moves sideways, holders can still collect the 3.41% dividend yield.

Conclusions

TLT has broken out and this should signal the second phase of the rally from the 2023 low is underway. This is likely driven by a slowing economy and the Fed shifting further dovish. TLT is positioned to make solid gains as it targets the $100-$109 area.