BofA Is Sticking With an October Rate Hike Even as Markets Bet Against It
Markets give a Fed rate hike in October just a one-in-five shot, but Bank of America is betting the consensus has it wrong, and the most rate-sensitive bond fund in the market sits dangerously close to a key floor with…
In a note on Monday, Bank of America (NYSE:BAC | BAC Price Prediction) said it still expects the Federal Reserve to raise rates at its October meeting. The decision is due Wednesday, October 28. Bank of America put the market-implied chance of that hike at just 20%, so its call is clearly a minority view.
Long-dated Treasuries fell the same day. The iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) traded at $79.46 late Monday, down 0.74% from Friday’s $80.05 close.
That leaves the fund much closer to its 52-week low of $76.43 than to its high of $92.19. It is down 5.65% year to date and 8.82% over one year.
If a major bank is right and markets are wrong, the most rate-sensitive mainstream bond fund has not yet priced in that risk. A bank forecast is still just a house view, and the Fed has decided nothing. If you hold TLT for income, you need to watch the gap between the forecast and market pricing ahead of the decision.
Inside Bank of America’s Case for a Hike
The bank wrote that “September inflation bolsters the case for an October hike” and that “the inflation picture has gotten worse since the Sep meeting.”
Bank of America said core PCE inflation, the Fed’s preferred gauge, could probably end the year at 3.4%, well above the 2% target. Its reasoning is that a booming nominal economy makes it easier for an energy shock to pass through to consumer prices.
Bank of America noted that most FOMC members backed two hikes this year. It asked why the second shouldn’t come in October, which would keep a December move possible. After a September increase, the upper bound of the Fed’s target range already stands at 4.00%.
The bank has “low conviction” that Fed Chair Kevin Warsh wants a “sea change” at the Fed. Even so, it is giving him “the benefit of the doubt.”
Why Duration Makes TLT the Most Exposed Fund
Duration measures how far a bond’s price moves when yields change. Because TLT holds bonds that mature in 20 years or more, even small yield changes move its price a lot.
A hike pushes up short rates directly. Long yields respond more to inflation expectations, and 20-year debt yielded 5.53% on October 19.
That supports a bull case: a Fed that shows it will fight inflation can hold down long yields even as it raises short ones. The 10-year yield has already declined to 5.15% from 5.31% on October 5.
Markets treat a hike as unlikely, so a surprise move would probably hit prices harder than a hold. A hold would give TLT some short-term relief. However, it could also suggest the Warsh Fed is less hawkish than advertised, which could let inflation expectations and long yields trend higher.
For retirees, TLT pays monthly income from Treasury coupons and has a 0.15% expense ratio. As yields rise, future income grows, but the fund’s price falls today.
That trade-off suits investors with long horizons who want a hedge against recession. It carries more price risk for investors who may need the principal within a few years.
What October 28 Could Mean for TLT Holders
Income-focused investors face elevated price risk in TLT heading into October 28. The fund sits near the bottom of its range because inflation is still rising, and a respected bank expects a hike that markets mostly ignore.
Treasury bills and short-duration Treasury funds carry less rate risk. On October 19, 1-month bills yielded 4.11% and 6-month bills yielded 4.37%, so funds that hold them pay income with little price risk from a hike.
The trigger is October 28. If the Fed raises rates and TLT stays above its $76.43 low, the bull case gains weight. A break below that level would confirm that the long end has not finished adjusting.
Contact [email protected] for any questions or corrections.
Omor Ibne Ehsan is a writer at 24/7 Wall St. He is a self-taught investor with a focus on growth, cyclical, and dividend equities that have strong fundamentals, value, and long-term potential. He also has an interest in high-risk, high-reward investments such as penny stocks.
