I am inclined to invest in the TLT ETF, as I foresee Treasury yields continuing to decrease as we approach year-end. The financial turmoil surrounding the auto parts giant First Brands has unsettled traders, leading to substantial, and arguably excessive, losses in many regional and other bank stocks. The decline in Treasury yields was mirrored by a sharp drop in stocks, particularly influenced by profit-taking and panic surrounding regional bank shares (KRE).
Traders are increasingly anxious about potentially problematic loans, especially following two recent bankruptcies that suggest lending standards may have loosened too much. However, I do not anticipate that these regional bank issues will escalate into a broader market crisis. The 10-year yield briefly reached 3.96%, marking its lowest level since April 7, while the 2-year yield fell to 3.41%, its lowest since September 8, 2022.
It’s important to note that one basis point is equivalent to 0.01%, and yields and prices move inversely. As of mid-October, Treasury Secretary Scott Bessent has advocated for additional interest rate cuts by the Federal Reserve. Following a quarter-point rate cut in September, Bessent expressed his expectation for a “series of rate cuts” and has openly criticized Fed Chairman Powell for not being more proactive in easing monetary policy. He has also indicated that models suggest the “neutral” rate is 150 to 175 basis points lower than the current range.
Expectations for two more rate cuts in 2025 have now surpassed 75%. Given the volatility in the market, I believe there are opportunities for rates to decline further. To manage the risk associated with this trade, I have defined my strategy in case my timing is premature.
The Trade
I bought the Dec. 19 $91 TLT call for $1.95 and sold the Dec. 19 $95 TLT call for $0.75. At the time of this trade, TLT was trading above $91. This is a debit spread that costs an investor $1.20, or $120 per one lot spread. For this trade to break even by expiration, TLT needs to be above $92.20.
DISCLOSURES: Kilburg is long TLT and long this call spread. All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company, or affiliates, and may have been previously disseminated by them on television, radio, internet, or another medium.
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