In high school, there was this thing called “high waters.” If your jeans or khakis showed any of your socks or, worse yet, the skin from your shins, there would be immediate laughing and name-calling. “Are you expecting a flood to come in tonight with those high waters on,” kids would jokingly reference. I was at my daughter's choir concert, and all the “cool kids” had the most prominent high waters you’ve ever seen. I guess that’s back in style and vogue. In investments, the trend is your friend, and things come in and out of favor based on markets, economies, government decisions, and on and on. This year an exciting surprise has been what we call an inverted yield curve with government treasuries. An inverted yield curve means you can earn higher rates on short-term government bonds (such as a two-year) than long-term government bonds (such as a 30-year). Thus, for a limited time, if you have funds you’d like to earn a fixed rate of return with a guarantee from the US Government, assuming you hold until maturity, treasuries may be an option worth considering.
What is a Treasury?
As a result of this being out of fashion for the last 15 years because of historically low-interest rates, you may not be familiar with what a treasury is, so let’s dive in. They come in three basic fashions: Treasury Bills which are marketable government debt instruments with a maturity of one year or less. Treasury Notes are marketable government debt instruments with two – ten years maturity. Finally, there are Treasury Bonds which are marketable government debt instruments that have a maturity of twenty years or greater. These debt instruments carry the full faith and credit of the United States Government. That means, if held to maturity, they will pay you back your total principal balance plus the interest quoted on the bond.
What is Marketable?
You may ask, “what do you mean by marketable?” When you think of buying a two-year bond, your mind most likely goes to the fact that you must keep the bond for two years. That is true if you want the government's guarantee, stating that they will pay back the bond's total value plus interest. However, because they are marketable, which means there is a market for them, a secondary market, you technically could sell the bond 13 months into your 24-month commitment to getting your money back. However, this is where it gets tricky. What you get back will depend on that bond's current value, which changes daily based on several factors, such as yield, maturity, and call features (if any).
Let’s use a quick real-life example. Let’s say you bought a two-year treasury in December of 2014, which would have been paying about 0.30% at the time (yuck). Then one year later, the Federal Reserve raised the Federal Funds rate by 0.25%. That increase had the effect of decreasing the price (market price) of that two-year treasury note you bought. Thus if you tried to sell it a month later, in January 2016, you most likely would have sold at a loss.
However, if you held to maturity in December 2016, you would have received all your principal plus interest payments with no loss. Thus, the price movements only affect you if you sell the bond early. If you hold to maturity, there is no problem at all.
When is Interest Paid & is it Taxable?
The interest is paid every six months and has unique tax benefits. The interest will be taxable at a federal level but exempt from state and local taxes. This makes the treasury a little more attractive if everything else is equal (credit risk, interest rate, duration) than a standard corporate bond because of the tax-free nature of a portion of the interest.
This is changing daily; however, to give you a feel for how unique the opportunity within treasuries is right now, check out the following charts to see the last ten years of yields on a 6-month, 1-year, 2-year, and 10-year treasury.
The 6-month yield. **As of 10/21/2022**
The 1-year yield. **As of 10/21/2022**
The 2-year yield. **As of 10/21/2022**
The 10-year yield. **As of 10/21/2022**
Bond or Cash Alternative?
Many clients have excess cash sitting in their checking, savings, or emergency fund. This is because they didn’t want to take risks with the money; however, they have no immediate need for these funds. They may consider a 3-month, 6-month, 12-month, or 24-month treasury as an alternative. If they're with a major bank, they’re probably getting 0.04% or less on their savings, and if they’re with a small or online bank, they may be getting 2-3% on their savings, and right now, even the 3-month treasury has an annual yield of over 4.00% (this changes daily so check current rates). With interest rates spiking this year, bond funds have had their worst year since 1842. That means your bond fund is more than likely taken quite the beating in 2022. Suppose your bond fund continues to carry a high duration (note Whitaker-Myers Wealth Managers does not invest in bond funds with a high duration). In that case, you should consider if rates continue to climb in 2022 and 2023, you may be better served in a Government Treasury.
GOVERNMENT TREASURIES: BACK IN VOGUE
October 23, 2022
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