Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, U.S., March 3, 2023.
Brendan Mcdermid | Reuters
The latest spike in bond yields was enough to spook the stock market into a sell-off Tuesday, but there's a silver lining for fixed income investors: Short-term Treasurys are now touting a risk-free return of 5%.
The latest action follows comments from Federal Reserve Chair Jerome Powell, who said Tuesday that interest rates are "likely to be higher" than previously expected. "If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes," he said.
The yield on the 3-month Treasury touched a high of 5.015% on Tuesday, the highest level since 2007. (Note: that yield is annualized, not what you would get in just three months.)
Rates on the 1-year bill and 2-year Treasury note – the latter of which is most sensitive to the Fed's policy – also popped more than 5% on Wednesday morning, reaching levels last seen in 2006 and 2007, respectively. Bond yields move inversely to prices.
Treasury rates have popped higher as the Fed continues its rate-hiking campaign.
A piece of the action
Short-term Treasurys are a great way to put idle cash to work, and you can also "ladder" them to get a little interest on your money over a certain term. This means you build a portfolio of issues with different maturities and reinvest the proceeds as they mature.
Investors can get in on the action in a couple of ways.
First, they can purchase Treasurys directly from the U.S. government via TreasuryDirect.gov. They will have to set up an account on the site and link their bank to it. For short-term investors, 4-week, 8-week, 13-week and 26-week T-bills are auctioned every week. Two-year notes are auctioned monthly, and 10-year Treasurys are auctioned every quarter.
If you hold the Treasury to maturity, you aren't subject to market risk. The bonds generally pay interest twice a year, but for T-bills, the interest you get is the difference between what you paid and the face value you receive at maturity.
Another way for investors to buy Treasurys is through a brokerage firm. This makes record-keeping easier for investors, especially if they already have an individual retirement account at a given firm.
The issue is that you may be subject to fees and minimum purchase requirements if you buy Treasurys through a brokerage account. Consider that you can buy Treasurys directly from the government with a minimum purchase amount of $100, but a brokerage firm can charge you for broker-assisted trades. Others require that you buy at least $1,000 in Treasurys.
Though Treasurys are considered risk-free because their payments are backed by the full faith and credit of the United States government, investors should be aware that the real rate of return they're earning could be eaten away if inflation rises at a pace greater than the yield. A further risk is they may also miss out on investment opportunities in other assets like stocks.
These bonds may be a great way to get some interest on otherwise idle cash, but they shouldn't make up the entirety of your portfolio.
— CNBC's Michelle Fox and Gina Francolla contributed to this story.
As a seasoned financial expert with a comprehensive understanding of the intricacies within the financial markets, particularly in the realm of fixed income securities and interest rate dynamics, let's delve into the concepts and nuances embedded in the provided article.
The article discusses the recent surge in bond yields and its impact on both the stock market and fixed income investments. The context centers around the Federal Reserve's stance on interest rates, with Chairman Jerome Powell hinting at a likelihood of higher rates than previously anticipated.
1. Bond Yields and Stock Market Interaction: The article emphasizes how the spike in bond yields triggered a sell-off in the stock market. This reflects the inverse relationship between bond prices and yields. When yields rise, bond prices fall, affecting investor sentiment in other markets, such as equities.
2. Short-Term Treasurys and Risk-Free Returns: Short-term Treasurys are highlighted as an attractive option for fixed income investors due to their risk-free return of 5%. This return is mentioned in the context of the 3-month Treasury yield reaching 5.015%, the highest level since 2007. It's crucial to note that the yield is annualized.
3. Federal Reserve's Influence on Bond Yields: Powell's comments regarding the expectation of higher interest rates have contributed to the rise in Treasury yields. The market reacts to signals from the Federal Reserve, and in this case, the expectation of a faster pace of rate hikes has impacted various Treasury maturities.
4. Laddering Short-Term Treasurys: The article suggests a strategy for investors called "laddering," wherein they build a portfolio of short-term Treasury issues with different maturities. This approach allows investors to reinvest the proceeds as the individual securities mature, optimizing returns over time.
5. Investing in Treasurys: Investors are presented with two primary methods to invest in Treasurys. They can either purchase them directly from the U.S. government through TreasuryDirect.gov, involving various maturities, or use a brokerage firm. The latter option simplifies record-keeping but may involve fees and minimum purchase requirements.
6. Risks Associated with Treasurys: Despite being considered risk-free due to the U.S. government's backing, the article mentions potential risks. Investors should be cautious about the real rate of return being eroded by inflation exceeding the yield. Additionally, the conservative nature of Treasurys may mean missing out on other investment opportunities in more dynamic assets like stocks.
In conclusion, this article underscores the intricate relationship between bond yields, interest rate expectations set by the Federal Reserve, and the strategic opportunities available to investors in short-term Treasurys. It provides valuable insights for individuals seeking to navigate the current financial landscape with a focus on fixed income securities.
