First a few basics about U.S. Treasury securities (you can also check an earlier post for links)–
- U.S. Treasury securities are investments in the debt of the U.S. economy.
- U.S. Treasury securities have been considered the safest securities in the world for investing.
- These securities are backed by the U.S. government, and no Treasury bill, note or bond has ever defaulted.
- U.S. Treasury securities are the ultimate safe investment; therefore, their yields tend to be lower than riskier corporate bonds.
There are several types of U.S. Treasury securities. A few include:
- Treasury bills, or T-bills, have short maturities (52 weeks or less) and thus are less affected by moves in interest rates.
- Treasury notes, or T-notes, are issued in terms of 2, 3, 5, 7, and 10 years, and pay interest every six months until they mature. When a note matures, you are paid its face value.
- U.S. Treasury bonds are issued in terms of 30 years and pay interest every six months until they mature. When a Treasury bond matures, you are paid its face value.
You can hold a U.S. Treasury security until it matures OR you can sell it prior to its maturity date.
- If you sell U.S. Treasury securities early, you can have a gain or loss depending on whether interest rates have risen or fallen since you bought the security.
- If interest rates have moved higher, the Treasury security price will fall.
- If interest rates have moved lower, the Treasury security price will rise.
Interest rates fluctuate with a growing or declining economy:
- In a growing economy, interest rates usually rise as many companies need additional funds to expand their business.
- As the yield (or interest rate) on a U.S. Treasury security goes up, the price of the security goes down.
- Many believe we are rebounding toward a growing economy. The stock market is reflecting economic growth ahead. Thus, we should expect a rise in interest rates to soon follow. But that is not what we see reflected in the U.S. Treasury bond yields.
Over the last few months, yields on long-term U.S. Treasury bonds have been going down. A growing economy and falling long-term interest rates do not usually go together.
There are two possible explanations for what lies ahead. Either, in the months ahead, we should see long-term interest rates move higher OR in the months ahead, we will realize that we are not in an economic recovery a second recession–called a “W” shaped recovery– will begin to emerge.
Lesson: Strong economies typically are associated with lower Treasury bond prices with rising yields. Today we are not seeing this traditional relationship. Anticipate a change in one of the following-either the economy and the stock market will fall OR interest rates will rise with Treasury bond prices falling.
