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The iShares U.S. Treasury Bond ETF (BATS:GOVT) is a way to get fixed income exposure and dollar exposure in a period where the narrative around US credit has fundamentally reverted back to it being an imperious store of value. The US is leveraging its geopolitical power fully in the war, and has been able to bear limited costs for very effectively undermining enemies, at the expense primarily of its allies. This is what the US has earned as being the dominant superpower. The only trouble with GOVT is that despite these positives, it is still very duration exposed. For that reason it’s a pass, but shorter maturity US credit is golden right now.
A Note on the War
While everyone is feeling the effects of inflation, as the commodities experiencing inflation trade on a global market, the situation is much more acute in Europe than the US due to the direct reliance on Russian supply for European energy needs. As opposed to scarcity merely driving up prices, in some countries scarcity is a hard limit, and rationing may have to occur.
To supplement an ailing supply, Europe has turned increasingly to the US and Norway for its energy needs, with gas now coming in through LNG tankers and regasification facilities rather than through the Russian pipelines.
Europe is more hamstrung in its ability to raise rates, as inflation has already eroded the pocketbook. Risk of unemployment after rate hikes remains a major concern for the ECB and a reason for the rate hikes to have been limited in their increases so far. Its savings rates are lagging the US.
The US benefits from a lot of home grown commodity production, including shale oil, which went from being accused as an untenable commercial venture to being entirely profitable, with very substantial margin over breakeven prices. The gas from shale oil is no longer flared off, that’s for sure. It is now a valuable export. In the meantime, Russian gas is likely going up in flames, since it will sooner do that than be sent to Europe. US credit, which was barely able to cover FX hedging costs, has gone from 0 yield to pretty decent yields in a span of some months, just as the environment became very risk-off due to the echoes from the Ukraine war, attracting lots of funds into US credit and the USD. This occurs without the cost of unemployment even, where employment remains stubbornly high. This has supported both the current account but also support on the financial side. No one is speculating over the USD losing reserve status now, and the US keeps a substantial premium over other developed nations, despite the substantial hit to tech stocks. Even the YTD declines in US indices are more limited than European peers, for example. In other words the US is coming out on top, and its financing conditions, while somewhat more expensive, have offsets from having affirmed the US exorbitant privilege around the dollar.
Conclusions
The GOVT ETF gives you exposure to improving US credit quality, as the demand for treasury instrument rises. It also gives you USD exposure, where the USD is likely to continue to stay very strong in the medium-term, possibly continuing to improve.
The problem with GOVT is the duration. It’s over 6 years on a weighted average basis. Its current 11.4% YTD declines seem limited compared to where they could justifiably be, given 6 years of duration accentuate rate hikes by a factor of 6x in terms of capital decline. Duration is terrible in the current environment, especially since inflation and employment stay stubbornly high. Rates will need to continue to rise to put a dent in inflation and that will come at the expense of GOVT. On every other basis, US treasuries are attractive, but not with this duration. Pass on GOVT.
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