30-Year Treasuries → Why Are Yields Spiking?

Issue 77

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Today’s Bullets:

• Reality of ‘risk free’

• Why are yields spiking?

• What are the implications?

• What should you do?

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Inspirational Tweet:

Well, I understand Bill Ackman is quite polarizing for investors. But if you just focus on his words here (please click on the Tweet above to see the entire post), he makes some important and strong points about US Treasuries.

Long-dated Treasuries, in particular.

And, if you have not yet noticed, Bill was right about the mis-pricing of USTs, especially the 30-year (notice the date of his post, 2 weeks ago).

But why was he saying rates are too low, and what are the implications of the observation?

Super important questions, I believe, ones we should be asking and answering today.

And so, if bonds scare you and this all sounds complex and confusing, you’ve come to the right place. We’ll get you all sorted out, nice and easy as always, here today. So grab your favorite mug of coffee and settle in for a few minutes with The Informationist.

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🤨 Reality of ‘risk free’

Before diving in here, a quick primer on bonds and Treasuries, what they are and how they work. For those of you who are comfy with this part, feel free to jump ahead.

But if you want a bit of a tune-up, let’s proceed.

First, bond prices are a function of both yield and duration. If interest rates rise, then bond prices fall to compensate for that move in yield. And vice-versa. The longer the duration, the more sensitive the bond price is to the interest rate move, i.e., the more the price will rise or fall to compensate for that interest rate move.

This is the mark-to-market function of bonds.

In the case of US Treasuries, they are issued in an auction and then they are free to trade on the open market.

But if yields rise or fall after a bond is issued, then the market price of that bond is adjusted to reflect the change in the going rate or effective yield of that bond.

And, as you can imagine, if a 1-month T-Bill is issued at 5% yield, and then two weeks later the Fed raises rates by .50%, the price of that bond will only decrease by 2 or 3 basis points (2 or 3 hundredths of a percent).

But if this was a 2-year note, the price impact would be more, even more than that for a 10-year bond, and if it was a 30-year Treasury, the impact would be quite large, as you can see below.

All of that said. If you were to hold the bond you bought in auction (or at the earlier and lower yield in the open market) until maturity, then these price moves will not matter to you.

You will receive the rate that you purchased the bond at, period.

But in this case, you still have two risks:

1. The risk that you need liquidity before the bond matures and you must sell your bond at a loss.

2. The risk that inflation runs higher than the yield you are receiving over the life of your bond, creating what we call a negative real rate of return (we will revisit this below).

And so, even US Treasuries, the global reserve asset are not without risk.

They are, in fact, not risk-free.

Fitch (and S&P) Ratings know this, and investors know this, too. And they have adjusted to account for these risks, among others.

Let’s unpack further, turning to current pricing.

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😮 Why are yields spiking?