TLT ETF and the upcoming $54 trillion black swan event

I wrote about the The iShares 20+ Year Treasury Bond ETF (TLT) last week and warned about an upcoming fiscal cliff as the US public debt surges. Turns out, the situation is worse than I thought after the CBO published a scathing report that revealed that the US public debt will surge to over $54 trillion in the next decade. 

The CBO estimated that the country’s budged deficit will surge from the current $1.6 trillion to over $2.4 trillion in this period while the economy will be worth about $34 trillion. This means that public debt is expected to grow at a faster rate than the economy.

The statement came a few days after Jerome Powell, the head of the Federal Reserve warned about the country’s fiscal situation in a 60 Minutes interview. This is a major issue that will likely lead to the biggest black swans in the US history. 

In the past, the US has handled black swan events through both fiscal and monetary policy interventions. For example, it provided a bailout worth over $700 billion to banks during the Global Financial Crisis (GFC). The government also provided trillions of dollars in cash during the COVID-19 pandemic.

The Federal Reserve also responds to these issues by cutting interest rates and then offering quantitative easing. My argument is that a time will come when the Fed and the government will not have the tools to handle these issues. 

For one, the US budget is now extremely stretched, with most of the tax collected going to pay interest, fund the military, and pay for health care. Most of the country’s discretionary spending is now being paid for by borrowing. This includes the supplemental that funds Ukraine, Israel, and the Indo-Pacific.

Worse, the two parties in Washington are not prepared to cut spending. Donald Trump, the most recent Republican President increased the country’s debt by over $8 trillion, mostly because of Covid-19. Joe Biden has also borrowed heavily to fund his COVID handouts, Inflation Reduction Act (IRA), and the CHIPS Act.

Notably, the two sides are not ready to do what is needed to put the economy in a good position. Republicans are not willing to increase taxes while Democrats are not prepared to cut giveaways. As such, I believe that the public debt will actually get to $54 trillion earlier than the CBO estimates. 

This brings us back to the TLT ETF, which is the most popular ETF for long-term Treasuries with over $50 billion in assets. The ETF, together with its peers like the VGLT, SCHQ, and VUSTX will likely remain under pressure as long-term bond yields jump as we saw last year.

Higher Treasury yields are usually a sign that prices are falling. In this case, the Federal Reserve is expected to maintain higher interest rates because investors will demand cover because of high default risks. This trend will likely lead to lower prices for these ETFs. In the immediate term, I suspect that Moody’s will downgrade the US Triple A rating in the coming months, joining S&P Global and Fitch

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