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INVESTING EXPLAINED: What you need to know about US Treasuries, the fixed-income bonds issued to raise money for the state
In this series, we break down the jargon and explain a popular investment term or theme. Here it is US Treasuries.
Chests full of gold?
I imagine a scene from Pirates Of The Caribbean, with chests of looted gold…
The reality is a little less reckless, though no doubt some market participants consider themselves downright mischievous.
US Treasuries are fixed-income bonds issued to raise money for the state. Our equivalent is gilts (gilt-edged shares of the UK government).
The workings of the $24 trillion US Treasuries market may be mysterious, but the ups and downs of these securities affect investment performance.
Arcane: US Treasuries are fixed-income bonds issued to raise money for the state
President Clinton’s economic adviser James Carville noted that if there was such a thing as reincarnation, he would like to come back as the US bond market because “you can intimidate anyone.”
Tell me more
Treasuries come in four varieties: bills, notes, bonds, and inflation-protected securities. Treasury Bills – “T Bills” – are short-term bonds with maturities ranging from four to 52 weeks.
They do not come with a ‘coupon’ (interest rate). Instead, they are issued at a discount to the face value of the bond. Treasury Notes – which pay interest twice a year – have maturities of two, three, five, seven and ten years. Treasury bonds have maturities of 10-30 years and also pay interest every six months. Treasury Inflation Protected Securities – Tips – offer indexing and also pay interest.
All risk free?
Treasuries are backed by the US government’s “full faith and credit,” with the bond’s face value guaranteed to be repaid at maturity. There is no default risk. But bond prices fluctuate with interest rates and other economic factors: when a bond’s price rises, its yield (yield) falls – and vice versa. Movements in US bond yields are closely monitored by stock market observers around the world.
The yield on the 10-year bond is considered an important US economic metric. Particular attention is paid to the spread between the yield on this bond and the yield on two-year bonds.
Why is that?
The yield on a two-year bond should be lower than that of a 10-year equivalent because so much can go wrong during the remaining eight-year period. But a “yield curve inversion”—when the yield on the two-year bond rises above that of the 10-year—is seen as a warning sign that a recession is imminent within a year or, more likely, within two years. However, some observers argue that this is a valid signal only if the inversion lasts for a long time.
Are you worried now?
Yes. Two-year yields are at their highest level since the early 1980s above those on 10-year bonds. It appears that investors fear that the US economy will be shaken if interest rates are raised further and faster.
Do my funds hold these bonds?
Treasury Notes and Tips make up a large portion of the Ruffer Investment Company’s portfolio. Other Treasuries, including T Bills, account for 22 percent. For more information on owning a bond fund, see the factsheet online.