TBF: Definitely Not The Time

The ProShares Short 20+ Year Treasury ETF (NYSEARCA:TBF) is a short ETF that tracks the daily return of an underlying index of Treasuries with more than 20+ maturity and scales it by -1x. There are some peculiarities about that, compounding is atypical for the TBF, and it could differ from a straight short over longer periods. With these sort of daily factor ETFs, including leveraged ETFs, being primarily designed for shorter term time horizons, TBF is mostly for a bet for rate hikes at a tenor that would break expectations and cause declines in high duration Treasuries. We think that the macro set-up gives no reason to expect the TBF ETF to payoff particularly well, with both longer and shorter term rate expectations tending towards an eventual pause if not a reversal.

Briefly on TBF

The underlying index tracks Treasuries which have a remaining maturity of more than 20 years. In other words, the duration of the underlying index is high, and the main effect that TBF will be tracking in the current environment is interest rates in relation to whatever the priced in expectations are right now. In particular TBF will perform if rates and their expectations continue to go up, particularly able to capture these effects in the short term.

The reason we specify the short term is because instruments like this carry some additional risks. While not a leveraged ETF, 20+ duration is high, and the effect is that the underlying index's performance is multiplied by -1x for each day. This is important because it confounds some compounding and anchoring effects, and can make the returns of TBF differ materially over time from a simple short of the underlying index, held over whatever period the short seller chooses to keep the position open. The expense ratio is 0.9%, which is not too bad a deal considering average borrowing costs for shorting, but TBF is really only suited for speculation over shorter periods. If this concept is not clear, review the prospectus of this instrument and of those like it because it is a feature and risk that needs to be properly understood.

Macro Setup Unfavourable

The macro setup for TBF is unfavourable. Observe the current structure of the yield curve.

As opposed to some months ago, the yield curve has flattened with more distant yield actually nearing current ones. This means that rate expectations are really quite high, with an expectation that higher yields will be necessary for the long-term, which was not the case before. In particular, this signals that the bond market is not pricing in a substantial probability of a decline in the economy, triggered perhaps by the banking industry, to warrant a turnaround in rates to the extent previously assumed with an expectations that inflation was passing (markets aren't so confident about that anymore).

We think this is naïve. The risks in the economy are quite meaningful, at least in the US economy. The Fed may not have calculated for higher borrowing and lending costs related to balance sheet asset depreciation in how they've modeled stress tests for the economy. That is what Jamie Dimon asserts. This means that the Fed may have to revise down their rate program in order to fulfil their dual mandate. If credit conditions tighten in an economy that has relied upon easy money for so long, it makes sense that the economy has a ways to fall.

The point is, there is a decent case speculating on lower rates to the detriment of the TBF. In the shorter term, correlation between equity markets and longer duration instruments doesn't help TBF either in this relief rally. While higher rates beyond what the market expects (perhaps one more rate hike) would be positive for TBF, TBF is not an instrument that is effective to sit on for longer periods, and it would be a little while before we get to a Fed meeting that breaks expectations. It is also likely in the meantime that we get more negative headlines around banking. We'd avoid this ETF.

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