Even As Yields Plunge, Buying The 10-Year Treasury Note May Make Sense
Investing.com | Aug 14, 2019 08:20AM ET
With a yield of about 1.62% and falling as this is being written, is there any reason to buy a 10-year Treasury note right now? Down from 2.7% at the end of 2018, the idea might seem as palatable as a root canal.
Nevertheless, many investors may be thinking through the question because of recent stock market volatility: a nasty May, a robust June, all-time highs in July and a 4% decline since. Perhaps more importantly, stocks are trading at levels seen before the fall 2018 market peak.
Meanwhile, the 10-year yield has fallen to nearly the level of the 2-year Treasury yield. For many, the inversion of the 10-Y:2-Y—where the longer duration debt instrument yields less than the shorter duration asset—is a strong signal a recession is on its way.
Nonetheless, there are some persuasive reasons to consider the 10-year note.
- Safe haven: To shelter money against the U.S.-Chinese trade battle, the single biggest reason for this year's stock market volatility and the reason this summer's equity rally has stalled.
- Liquidity: The note will pay off at maturity because it's backed by the government. It's liquid and can be fairly easily sold if you need the cash.
- Higher yields than savings accounts or some other sovereigns: If nothing else, the yield is better than one would get opening a savings account or buying 10-year notes from any number of countries where yields are now negative. These would include Germany, France, Sweden, the Netherlands, Japan and Belgium.
- Profitability: Lastly, there is a chance you could actually make some money from the 10-year note even with yields so low. That will happen if rates continue to fall, as many expect and U.S. President Donald Trump fervently hopes.
Get The News You Want
Playing out this idea—of making a profit from the 10-year right now—would work like this if one invested in a $10,000 note at the date of issuance.
Bonds are valued in two 'pieces.' First is what would be generated at current value of all the payments an investor would receive from the note. If the coupon rate on the note is 1.625%, that would be $81.25 twice a year for 10 years. Discounting those payments at yesterday's yield of 1.68%, their present value would come to about $1,490.
Then there's the present or current value generated for the $10,000 face amount of the note. At 1.68%, that's about $8,460. That brings the total investment needed to about $9,950 before transaction costs.
Let's say the 10-year yield falls to 1%. Lower interest costs mean the present value of both the payments and the face amount will rise. Should that happen, the total value would be boosted to about $10,953. A gain of about 6.5%.
Overall, falling interest rates this year have fueled a big rally in bond prices and, separately, in prices for exchange-traded funds, such as iShares 20+ Year Treasury Bond (NASDAQ:TLT), iShares 7-10 Year Treasury Bond (NASDAQ:IEF) and Vanguard Intermediate-Term Government Bond (NASDAQ:VGIT), which all concentrate on medium-term government bonds have jumped this year, regularly hitting 52-week highs in recent weeks.
Bear in mind: a continuing yield decline to 1% may require some time and that will cut into returns. But that's the potential. The odds of lower rates are good because governments around the world are desperate to see their economies grow and believe lower rates will get them there.
All that said, the obvious point should be clearly noted: Nothing is guaranteed. And rates could suddenly turn for a variety of reasons. If that happens, the value of this investment falls, which means it's critical to pay ongoing attention to bond yields.
The 10-year note can be purchased directly from the Treasury, which requires opening an account at TreasuryDirect and setting up the mechanism to bid and pay for the note. Minimum investment size is $100.
Treasury notes can also be bought via brokers or banks, though investors are then subject to the institution's rules and fees. Plus, the bank or broker must be used to sell the asset as well.
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.