The Daily Observer London Desk: Reporter- Kathryn Williams
INVESTING EXPLAINED: What you need to know about US Treasuries and the government bond market
Chests full of gold?
I am picturing a scene out of Pirates Of The Caribbean, with chests of plundered gold…
The reality is rather less swashbuckling, although doubtless some participants in the market consider themselves as full of derring-do.
US Treasuries are fixed-income bonds issued to raise money for the state. Our equivalent are gilts (UK government gilt-edged stocks).
The workings of the $24 trillion US Treasuries market may be arcane, but the ups and downs of these securities have a bearing on investment performance.
James Carville, economic adviser to President Clinton, remarked that if there were such a thing as reincarnation, he would like to come back as the US bonds market because ‘you can intimidate everybody’.
Tell me more
Treasuries come in four varieties – Bills, Notes, Bonds and Inflation Protected Securities. Treasury Bills – ‘T Bills’ – are short-term bonds with maturity terms ranging from four to 52 weeks.
They do not come with a ‘coupon’ (interest rate). Instead they are issued at a discount to the bond’s face value. Treasury Notes – which pay interest twice a year – have terms of two, three, five, seven, and 10 years.
Treasury Bonds have terms of 10-30 years and also pay interest every six months. Treasury Inflation Protected Securities – Tips – offer index-linking and also pay interest.
All risk-free?
Treasuries are backed by the ‘full faith and credit’ of the American government, with the face value of the bond guaranteed to be repaid on maturity.
There is zero default risk. But the prices of the bonds fluctuate with interest rates and other economic factors: when the price of a bond rises, its yield (the return) falls – and vice versa. The movements in US bond yields are closely monitored by stock market observers all over the globe.
The yield on the 10-year bond is regarded as a key US economic benchmark. There is a particular focus on the spread between the yield on this bond and the two-year bond yield.
Why is that?
The yield on a two-year bond should be lower than that on its 10-year equivalent because over the remaining eight-year period, so much can go badly wrong.
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 that recession looms within the next year, or, more likely, within the next two years. However, some observers argue that this is only a valid signal if the inversion lasts for a long-ish time.
Any concerns just now?
Yes. Two-year yields are at their highest level above those on 10-year bonds since the early 1980s. It seems investors are fearful the US economy could be left reeling if interest rates are raised further and faster.
Do my funds hold these bonds?
Treasury Notes and Tips make up a large chunk of the Ruffer Investment Company’s portfolio. Other Treasuries, including T Bills, account for 22 per cent. For details on the holdings of any bond fund, check its fact sheet online.
