VGLT: Buy Duration To Lock In A 4.5% Yield And Possibly Significant Capital Gains

Vanguard Long-Term Treasury Index Fund ETF Shares (NASDAQ:VGLT) is an ideal way to buy longer duration U.S. Treasury Bonds and lock in a yield of about 4.5% (SEC 30-day yield). This yield is close to what money market funds currently offer, but investors who remain in money market funds are likely to see yields plunge over the next couple of years. As most investors know, Vanguard offers investors some of the lowest expense ratios, and this remains true with this ETF, which has an expense ratio of only .04%. This ETF has about $17 billion in assets and also offers liquidity with significant daily trading volumes.

VGLT pays a distribution to shareholders on a monthly basis. The most recent payout was on April 4, for $0.1998 per share for shareholders of record on April 2, 2024.

The One-Year Chart

As the chart below shows, this ETF hit lows of about $51 per share in October, 2023, but then surged to around $62 per share in December. This December rally occurred primarily because Jerome Powell indicated the Federal Reserve was essentially done raising rates. That seemed to have created a relief rally in longer duration bonds which have been pummeled ever since the Fed started one of the most aggressive rate hiking cycles in history. However, there has been a pullback from the December highs, and this ETF now trades for about $57, which I believe is giving investors another solid buying opportunity. Currently, there is a bullish “Golden Cross” formation showing on the chart with the 50-day moving average of $58.50, being above the 200-day moving average which is around $57.71.

The Five-Year Chart

I think it is important to look at the five-year chart as well, because it offers a different perspective. With this chart, you can see that VGLT peaked at roughly $95 per share in 2020. If you consider the high of around $95 and the low of about $51 that this ETF traded at in October, this reflects a nearly 50% decline in value, which is an enormous amount of volatility for a bond fund. This makes me believe that the move down to current levels is probably an overshoot and that a rebound will eventually occur, but just not to the $95 level, unless we experience a major recession. Therefore, there is a good chance that long term bonds have put in a bottom and now could be poised to offer a high yield and significant capital gains as rates likely decline over the next couple of years.

Why It’s An Opportunity To Lock In Duration And High Yields Now

On March 20, 2024, the Federal Reserve released projections (the Fed dot plot), which suggests a 2.25 point drop in the Fed Funds rate by the end of 2026. This would reduce the Fed funds target rate from the current range of 5.25% to 5.5%, to a range of 3% to 3.25%, by the end of 2026. This would be a nearly 40% drop in rates over the next couple of years. So, if these projections are correct, it means that long duration bonds could jump in value, as yields potentially plunge. However, in the past few days, a bunch of Fed officials have seemingly been trying to walk back these projections, especially after a recent jobs report came in fairly strong. Because of this sudden pushback on the idea of lowering interest rates, (which many investors believed could happen in June), long-duration bonds have dropped in value over the past week or so, and that is giving investors an ideal buying opportunity with VGLT.

It is possible that the Fed won’t cut rates in June as many were expecting, or that the Fed won’t cut rates three times in 2024. If we see a “higher for longer” type of interest rate policy, I don’t believe it will be higher for much longer. I also take projections and statements from the Federal Reserve with a grain of salt because the track record from Fed officials is lacking in terms of accuracy. For example, back in 2021, the Fed said repeatedly that inflation would be transitory and it downplayed the chance of rate hikes.

So for me it makes little sense to hang on every word of every Fed official because I firmly believe that it is just a matter of time before economic data weakens. Whether the Fed is cutting rates in June or a bit later is not going to make much difference in the end. What will make a difference is if we see a sudden and surprisingly aggressive move in the price of bonds and that is why I am positioning my portfolio for the next few years, and not just for potential rate cuts in June. In my opinion, rates are going to drop either because the Fed did so willingly before the economy shows major weakness, or rates will drop on their own because of a sudden economic downturn and the Fed will follow by cutting rates.

BlackRock Is Bullish On Long-Duration

A recent CNBC article quoted BlackRock as stating “this was the last best opportunity” to buy bonds and notably, the article points out that potential downside risks appear limited; it states:

“And while traders keep dialing back their expectations for the number of Federal Reserve rate cuts this year, the consensus is that the central bank’s benchmark rate has already peaked at the current 5.25%-5.50%. That means that long-term bonds should have limited downside risk from here, with the potential to jump in price whenever the Fed does cut.”

The article also mentions that BlackRock sees investors as being overweight cash and underweight duration in their portfolios. This means many investors could be too complacent right now with a significant amount of their money being parked in money market funds. With money market funds currently yielding just over 5%, it is easy to see why many investors would not want to swap out of this yield and get into a long-duration bond ETF like VGLT which “only” yields about 4.5%. However, when Fed Funds (and money market) rates do drop to what could be about 3% by 2026, the investors who made the move into duration (even if it is a bit early) will be way ahead and likely to be enjoying capital gains on top of the higher yields they locked in.

Potential Downside Risks

I agree with BlackRock that the potential downside risks in longer duration bonds could be limited at this level. However, if oil continues to rise and housing prices keep increasing, these are two significant factors that add to inflation and that could make it very difficult for the Fed to lower rates. That would lead to a higher for longer scenario which could keep bond prices at depressed levels or even push prices lower. In this case, we could see VGLT re-test the $51 level. I think this would just be a chance to buy and add more duration to my portfolio because high interest rates will eventually lead to a potentially major recession and rates will then plunge.

In Summary

This recent pullback in longer duration bonds seems to be a buying opportunity, and perhaps one of the best and final chances to add duration to a portfolio. I think too many investors are complacently leaving high levels of cash in money market funds and therefore these investors will be caught off guard when rates eventually plunge. If we are in for a higher for longer rate policy by the Fed, perhaps it is a little early to buy long-duration bonds aggressively, but I would rather be a little early than late and miss a potentially significant move higher in the share price for VGLT.

No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.