Not every investor keeps abreast of this, but the U. S. Treasury securities yield curve, which shows the difference between long-term and short-term bond rates, is the “flattest” since 2008.
In other words, you don’t earn much more by tying your money up for, say, 10 years rather than two years. So it may be hard to justify the risk of owning a long-term Treasury bond.
“Income-oriented investors are not likely to find much value in Treasury bonds right now, and may only want to invest in them if they insist on having the highest level of credit and liquidity available,” says Michael Skirvin, head of quantitative research and portfolio strategy at Gurtin Fixed-Income Management of San Diego and Chicago.
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Other types of bonds pay more, but there’s danger in grabbing the highest-paying bond. “We recommend caution for investors who may be tempted to reach for yield,” says Colin Lundgren, head of fixed income for Columbia Threadneedle in Minneapolis.
He says high-yield, or junk bonds, offer higher yields but carry a risk of default, as do generous-looking bonds from developing countries.
The yield curve is a line on a graph where the vertical axis shows bonds’ annual interest payments and the horizontal shows time until the bond matures, when investors get their principal back. Normally, bonds that mature in a few months or years pay much less than ones that take five, 10 or 30 years to mature.
That’s because investors won’t buy long-term bonds unless they are compensated for all the bad things that could happen over time. Inflation could spike, making a given yield less valuable. Or newer bonds could offer higher yields, undercutting the value of older bonds that are less generous. Or the bond issuer — a company or government — could default, failing to pay the interest and return principal as promised.
In January 2014, the difference between the yields on 10- and two-year Treasuries was about 2.6 percentage points. The 10-year paid about 3 percent, the two-year Treasuries paid about 0.4 percent.
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That spread was less than 1 point on May 30, with the 10-year paying about 1.8 percent, the two-year about 0.9 percent.
Bond yields are set by a complex interplay of government policy and market forces. In the U.S., the Federal Reserve has a good deal of control over very short-term bond yields like the federal funds rate, which banks charge one another for overnight deposits. But yields on longer-term bonds are set by supply and demand forces in the marketplace, based on what investors expect markets, the economy and government policy to do in the future.
Short-term rates have been inching up because many investors think improvements in the economy will lead the Federal Reserve to raise the short-term rates it controls to head off inflation. But long-term rates have been drifting downward, largely because investors don’t see much danger of inflation.
“The flat U.S. yield curve is telling you that the market is not overly concerned about the Fed falling behind the curve when it comes to keeping inflation in check, as inflation is currently well-contained,” Lundgren says.
Long-term Treasury yields remain low because investors, especially overseas, are content with low yields as a tradeoff for safety, he says: “While U.S. government bond yields may appear low to mom-and-pop investors in the U.S., they appear very attractive to investors in Europe and Asia where the alternative is no yield or even negative yield.”
For many, the investing question is whether owning a longer-term bond pays enough to compensate for the risk. If prevailing rates were to rise, prices of those bonds would fall, since investors would rather buy newer bonds that pay more. Those holding the older, stingier bonds could sell at a loss, or hold them to maturity to receive the full face value. But that could mean living with poor interest earnings for years, or foregoing bigger profits on other investments like stocks.
One alternative, Lundgren says, is high-quality corporate bonds. “They offer reasonable yield premiums — slightly above average by historical standards — for a high quality income stream,” he says.
Vanguard’s Intermediate Term Corporate Bond index fund, for instance, yields just over 3 percent, compared to just over 1 percent for the firm’s Intermediate Term Treasury Fund (ticker: VFITX).
Thomas G. Doe, president of Municipal Market Analytics in Concord, Massachusetts, says municipal bonds offer another alternative to Treasuries, especially for investors in higher tax brackets, who benefit most from tax-free interest earnings. While municipal bonds are not quite a safe as Treasuries, highly rated ones are considered pretty safe.
Still another option is Treasury Inflation-Protected Securities, or TIPS, says Dan Dektar, chief investment officer of Amundi Smith Breeden, an asset manager based in Durham, North Carolina. TIPS offer steady interest earnings while the bond value rises in lockstep with inflation. Currently, TIPS pay nearly as much as Treasuries with the same maturities, while offering the same low risk of default and better results if inflation picks up, he says.
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A final option is to sit tight, opting for short-term Treasuries, money market funds or simple bank savings instead of long-term securities. That way you could get your money quickly when better opportunities arise.
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How to Invest With a Flat Yield Curve originally appeared on usnews.com
