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A fiscal cliff is coming: avoid the SCHQ and TLT ETFs

By: Invezz

The Schwab Long-Term US Treasury (SCHQ) and the iShares 20+ Year Treasury Bond (TLT) ETFs have jumped sharply in the past few months as investors cheer the change of tune from the Federal Reserve. They have both risen by almost 20% from their lowest point in 2023, pausing the sharp plunge that started in March 2020.

TLT vs SCHQ

SCHQ vs TLT ETF chart

US government debt is soaring

SCHQ and TLT are popular ETFs that track long-term government bonds, which have been known as the safest assets in the world. Recently, however, these funds have come under intense pressure as interest rates have jumped to their highest point in over two decades. The Fed has constantly left rates between 5.25% and 5.50%.

In most cases, long-term government bonds are less attractive when the Fed is hiking interest rates because it makes shorter-term ones more attractive. Indeed, ETFs that track short-term government bonds like BILL and SHV have done better in the past few months.

Therefore, the SCHQ and TLT ETFs have rebounded recently because of the Federal Reserve’s signal that it will start cutting rates later this year. As I wrote here, most analysts expect the Fed to leave rates on Wednesday. It will then sound a bit hawkish because the economy is doing better than expected while inflation is still stubbornly high.

The SCHQ and TLT ETFs face a major risk in the long term as the US government bonds continue surging. Data by the Treasury Department shows that the total public debt has surged to more than $34.3 trillion. Worse, the government is adding $1 trillion every 140 days, meaning that it will end the year at over $37 trillion.

The challenge is that the government is not committed to solve the debt crisis. Biden wants to keep spending while Trump, his main competitor, is also a believer in government spending. He added $8 trillion in debt in his first term as president.

Fiscal cliff is coming

The biggest challenge is that the government has little room to even solve the crisis. For one, most of the government spending is in autopilot since it includes mandatory items like social security, interest, Medicare, and defense. Non-discretionary spending, which most politicians spends most of their time talking about represents just a small part of spending.

Many respected economists have warned about the impending fiscal cliff in the US as the public debt gets out of hand. Robert Rubin, the former head of the Treasury under Obama, warned that the situation will get worse as the budget deficit worsens. Other economists like Larry Summers and Jamie Dimon have also warned about the crisis.

So, what does this mean for the TLT, VGLT, and SCHQ ETFs? The implication of all this is that the US will likely lose its final Triple A credit rating from Moody’s in the next few years. This, in turn, will lead to stickier interest rates as the bond market demands more protection. 

Worryingly, it is even not clear who the bond buyers will be since the historical big buyers like China, Japan, and Saudi Arabia are no longer buying. Therefore, while these ETFs could rise this year as hopes of interest rates, their long-term outlooks is bearish.

Watch here: https://www.youtube.com/embed/4KKsyw78XqY?start=569&feature=oembed

The post A fiscal cliff is coming: avoid the SCHQ and TLT ETFs appeared first on Invezz

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