Before the Rate Cut Implement: Exploring the Investment Potential of U.S. Long-Term Treasury ETFs

U.S. Extended Duration Treasury ETFs primarily invest in long-term Treasury bonds, with maturities typically exceeding 20 years, and in some cases, over 30 years. Here are their main characteristics:

High Sensitivity: Due to their long duration, U.S. Extended Duration Treasury ETFs are highly sensitive to interest rate changes. The longer the duration, the greater the bond price's reaction to interest rate fluctuations.

Significant Capital Gain Potential: In a rate cut environment, long-term bond prices rise more significantly, providing investors with substantial capital gains.

Lower Current Yield: Long-duration bonds generally offer lower coupon rates, hence the current yield of Extended Duration Treasury ETFs is typically lower than that of short-term bonds.

Potential Default Risk: Although U.S. Treasury bonds are considered one of the safest investments globally due to the backing of the U.S. government's credit, they are not entirely free from default risk. Investors still need to be aware of the macroeconomic and fiscal conditions to mitigate potential default risks.

Long-Term U.S. Treasury ETFs generally invest in Treasury bonds with maturities ranging from 10 to 30 years. In contrast, Extended Duration Treasury ETFs invest in bonds with even longer maturities. The main differences between the two include:

Long Duration: Extended Duration Treasury ETFs typically have a longer duration compared to Long-Term Treasury ETFs, making them more sensitive to interest rate changes.

Yield and Risk: Extended Duration Treasury ETFs may offer higher capital gains in a rate cut environment but also carry greater interest rate risk. During periods of rising interest rates, the prices of Extended Duration Treasury ETFs may decline more rapidly.

Market Demand: Due to their longer duration, Extended Duration Treasury ETFs attract investors aiming for maximum capital gains in a rate cut environment, whereas Long-Term Treasury ETFs may be more suitable for those seeking stable income and lower risk.

The impact of rate cuts on the bond market is primarily achieved through the adjustment of market interest rates. For U.S. Extended Duration Treasury ETFs, the impact of rate cuts is particularly significant, with extremely high price elasticity. Here are the specific impacts:

Price Increase: Rate cuts lead to lower market interest rates, making newly issued bonds with lower rates less attractive, thus increasing the attractiveness and prices of existing higher-rate bonds.

Yield Decline: Although bond prices rise, their yields decrease, as bond price and yield are inversely related.

The impact of rate cuts on the price elasticity of U.S. Extended Duration Treasury ETFs can be explained through the following mechanisms:

Discount Rate Reduction: Rate cuts lower the discount rate for future cash flows, increasing the present value of future cash flows, thereby pushing up bond prices. Given the long duration of Extended Duration Treasury ETFs, their future cash flows span a greater time horizon, making them more sensitive to changes in the discount rate.

Market Expectation Adjustment: Rate cuts are typically implemented to stimulate economic growth and reduce borrowing costs. Investors anticipate that future interest rates will remain low and therefore turn to purchasing long-term bonds to lock in relatively higher yields, further driving up bond prices.

Portfolio Adjustment: In a rate cut environment, investors often adjust their portfolios by increasing allocations to high-sensitivity bonds (such as Extended Duration Treasuries) to pursue higher capital gains. This increased demand also drives up bond prices.

Historical data shows that during rate cut cycles, U.S. Extended Duration Treasury ETFs generally outperform short-term or intermediate-term bond ETFs. For instance, during the 2008 financial crisis, the Federal Reserve significantly cut rates, leading to a substantial increase in long-term bond prices, with Extended Duration Treasury ETFs performing exceptionally well. This demonstrates that rate cuts have a pronounced positive impact on the prices of Extended Duration Treasury ETFs.

In a rate cut environment, U.S. Extended Duration Treasury ETFs, due to their long duration and high interest rate sensitivity, often provide substantial capital gains. However, this also comes with higher interest rate risk.