The new administration being relatively new to actual real world financing, has gotten its first hint of the trouble yet to come through a yield upward POP at the latest bond sale of 30 year bonds.
The government has to sell a lot of bonds, to finance its cash needs (deficit financing).
These sales are made to provide the long term funding for the government. There is only one catch, investors have to buy them. These buyers may include those investors who were shafted by the government into accepting an unfair deal on their Chrysler secured debt for instance, or had to forgive the debt; thus they had no money to buy the bonds.
Other buyers who have money, wanted to get a better interest rate on them, if they were to park their money for 30 years, and why not that's a long time to get a paltry return.
What happened today was that the yield went up, thus causing the price to go down. This is always the case, when yields go up the bond price goes down. So, somebody holding these bonds for the entire 30 years (a crazy person for instance) would see the interest rate remaining the same on his original investment, but the sale price of the bonds would decline substantially if the rate goes up to say 7%.
It may thus be a bad idea to buy the bods right now, not if their price continues to decline. In fact, why buy them at all?
The bonds will always be sold, because the free market will adjust to a higher yield for instance, to make them an attractive buy for investors. The bigger question is how many investors are there still willing to buy them.
I seem to recall that Russia, China and Japan, who are our largest holders of government bonds and notes stated that they will have little interest in buying more in the future. What then?, what happens if nobody wants to buy any?
reasury 30-year bonds fell the most in about four months as investors demanded higher-than-forecast yields at today’s auction of $14 billion of the securities with the U.S. slated to sell a record amount of debt this year.
“This is a problem,” said Chris Ahrens, head interest- rate strategist at UBS Securities LLC in Stamford, Connecticut, one of 16 primary dealers required to bid in Treasury auctions. “The market required a fairly significant discount to buy the bonds.”
Yields on the securities climbed to a six-month high as the bond auction drew a yield of 4.288 percent, higher than the average forecast in a Bloomberg News survey of seven bond- trading firms for a yield of 4.192 percent. Demand was below average, judging by total bids.
The benchmark 30-year bond yield climbed 16 basis points, or 0.16 percentage point, to 4.26 percent at 1:22 p.m. in New York, according to BGCantor Market data. The 3.5 percent security due in February 2039 dropped 2 18/32, or $25.63 per $1,000 face amount, to 87 10/32. The 10-year note yield increased nine basis points to 3.28 percent.
The auction’s so-called bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.14, compared with an average of 2.24 at the past 10 sales of the maturity. Thirty-year bonds yielded 3.64 percent at the last sale, on March 12.
Today’s auction began the Treasury’s monthly sales of the so-called long bond, up from quarterly offerings at the end of last year. That means the government will boost sales of the security from $35 billion in 2008 to $120 billion this year, according to Michael Pond, an interest-rate strategist in New York at Barclays Capital Inc., one of the 16 primary dealers that trade with the central bank and are required to participate in Treasury auctions.
‘More Attractive’
The yield on the benchmark 30-year bond reached 4.2820 percent, the most since Nov. 14, while the 10-year yield touched 3.3005 percent, the highest since Nov. 25.
“Treasuries are getting more attractive here,” said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. If 10-year note yields rose to 3.3750 percent, it would be “a good entry point for a short-term trade,” he said.
Our government may have a free market lesson in finance soon.Basics of Treasury Bonds & Securities Explained
Posted By Jim On Monday - 01/26 @ 7:34 am In Investing | 12 Comments
Between the various bailouts, rescues, and spending packages, the United States Treasury has been working overtime issuing debt. If you’re like me, you’re probably wondering how this is even possible and how the government goes about doing it. During the First World War and World War Two, we went through a similar period where the government needed to borrow a lot of money to help fund the war effort. That gave rise to the patriotic posters that called for ordinary Americans to buy war bonds to support our soldiers fighting the enemy on foreign soil. That same mechanism, public debt, is what we use today to help fund many of our programs. This makes it a prime topic for the third installment of the Foundation Series [1].
Relative Safety of Treasury Bonds
Before I get into the various instruments, the basic idea behind government bonds is that they are the safest investments in the world and that they are “backed by the full faith and credit of the United States Government.” When you buy stock in a company, there is a chance the company goes bankrupt and your shares are worthless. When you buy a corporate bond, there is a chance that the company goes bankrupt and your bonds are worthless. When you put your savings into a bank account, there is a chance that the bank fails, an almost impossible chance that FDIC insurance fails, and your money is worthless. When you put your money into a government bond, the government will collapse before you will lose your money. Being backed by the full faith and credit of the United States Government is an ironclad guarantee that your money is safe.
That guarantee, while comforting, is a bit illusory because we use a fiat currency that has no inherent or intrinsic value. Our dollars, or federal reserve notes, are themselves given value by government order (fiat) rather than an inherent value. However, despite this minor technical note, government bonds are still safer, from a capital preservation perspective, than every other investment.
Types of Treasury Bonds
When it comes to debt instruments, the name “bond” only appears in four of the seven debt instruments the Treasury issues because only three are truly bonds. A Bond is a very general term, it typically refers to a debt security where the issuer of the bond owes the holder of the bonds a debt. The bond itself has a coupon or interest rate at a certain interval and return the principal at a future date. Companies issue bonds, municipal government issue bonds, and the government issues bonds.
The other four debt instruments are called “securities” or marketable securities because they can be traded on the secondary market. Here is the list of products and a brief discussion of each:
- Treasury Bills (T-Bills) - T-Bills mature in one year or less and do not pay interest. Instead, they are sold at a discount of the par value (face value) paid out at maturity. T-Bills are sold at auction every week in increments of $100 and an individual can purchase up to $5 million per auction.
- Treasury Notes (T-Notes) - T-Notes mature in two to ten years and offer a coupon or interest payment every six months. The 10 year T-Note is the Treasury most often quoted in discussions about the bond market. T-Notes are sold at auction every week in increments of $100 and an individual can purchase up to $5 million per auction.
- Treasury Bonds (T-Bonds) - T-Bonds mature in ten to thirty years, have a coupon payment every six months and are issued quarterly. T-Bonds are sold at auction every week in increments of $100 and an individual can purchase up to $5 million per auction.
- Treasury Inflation-Protected Securities (TIPS) - TIPS were introduced in 1997 and are inflation-indexed bonds, pegged to the Consumer Price Index, in maturities of 5-year, 10-year, and 20-year. The coupon rate rate remains constant by the principal is adjusted for inflation (and deflation) every six months, but you the principal will never adjust below the principal you paid. TIPS are sold at auction every week in increments of $100 and an individual can purchase up to $5 million per auction.
- I Bonds - Series I bonds are very popular now, I just bought Series I bonds [2] for the first time this year, because they are sold at face value but have an interest rate that adjusts with inflation. Each bond has a fixed interest rate, that stays for the life of the bond, and a variable interest rate, which is indexed to the rate of inflation. The equation used is a little tricky to look at but easy to compute (here’s a Series I rate calculator [3]). Here’s a comparison between Series I Bonds and TIPS [4], the two inflation indexed offerings from the Treasury.
- EE/E Bonds - Series EE bonds are issued at 50% of their face value and mature in 30 years, though as it accues interest semi-annually, it is designed to reach face value in only 17 years.
- HH/H Bonds - Series HH bonds are no longer offered as of August 31st, 2004, but they were similar to EE/E bonds in that they were sold at a discount and mature in 20 years at face value.
Tax Considerations
One of the benefits of these products is that interest is exempt from income tax on the State and local level (but not Federal level). Some of the bonds, such as the Series EE/E and Series I Savings Bond, offer education tax savings. If you use the interest from an Series EE/E or a Series I Savings Bond to pay for eligible education expenses, it is tax free! Couple that with the Lifetime Learning or Hope Credits and you can get some serious tax savings.
Risks
There are risks to buying Treasury Bonds and similar debt instruments. The two major risks are inflation risk and currency risk.
Inflation risk: Inflation risk refers to the risk that your purchasing power will fall as inflation increases. If you have a coffee can stuffed with a thousand dollars buried in your back yard, you can be pretty sure that the $1,000 will still be there when you dig it out of the ground in five years. However, the $1,000 is worth less in five years because the value of a dollar will have fallen due to inflation. The same is true for money saved in bank accounts, CDs, or anything else not pegged to inflation. If inflation is 5% a year, you lose five dollars out of every hundred dollars each and every year. This risk is dangerous because it’s difficult to see with your eyes. You still see your thousand dollars sitting there, but you forget that the jar of peanut butter you buy each month or the gallon of milk you buy each week has gotten a little more expensive (or they shrank the jar!).
Currency risk: Another risk you face is that the dollar loses its value against other currencies. This is important because you’ll probably be buying products manufacturer or produced overseas and so your purchasing power will once against be tested. If you lock up your funds in a bond or CD, the risk that the dollar’s value goes down will have an impact on your savings.
Are these two reasons enough to preclude you from putting your money into a bond (or CD or savings account)? I don’t think so, but you need to be aware of them.
Where & How To Buy
You can buy some of the bonds at your local bank but the best and easiest place to do it is through the government’s TreasuryDirect [5] website. Setting up an account is fairly straightforward but be sure you get all the details right the first time. Making a change to your account will require a stamp from a bank official, which may be a pain to get if you’re working regular 9-to-5 hours at your job.
Also, you can buy paper bonds and convert them into electronic bonds [6], but having done that myself I have to say it was a little confusing. You have to create a Conversion Account that’s separate, but accessible, from your regular TreasuryDirect account. Then you have to create a manifest and mail in the paper bond with the manifest. It’s not impossible, but avoid the headache if you can.
Where & How To Sell or Redeem
So you have some savings bonds and you want to sell or redeem them, you have a few options based on what kind of certificates you have. Selling and redeeming a bond are two different things, though both result in the security or bond being taken away and replaced with money. Some of these investments, like TIPS, cannot be closed before they mature, so the only way for you to recover your money is to sell your TIPS. Some of these investments, like Series EE bonds, cannot be sold or transfered to another person, so the only way to recover your money is for you to redeem them. Now that we have that cleared up, here’s how you do either.
Electronic certificate: If you have an electronic bond you bought through TreasuryDirect, just log into your account and sell or redeem your bond through the website. In fact, if it’s a security, you don’t have to do anything because they will close the security and transfer the funds to your account. This is by far the easiest.
Paper certificate: If you have a bond, such as an I or EE bond, you can cash in your bond at most local financial institutions, call beforehand to confirm. You’ll need to bring some ID to prove its yours. You can only redeem up to $1,000 in bonds at one time without having to subjecting yourself to further identification (beyond a driver’s license). Don’t sign the bond until you’re in the presence of a certifying officer at the bank and they should take care of the rest.
If you have a security, such as a TIPS, you’ll have to sell it. To sell it, you’ll need to get your hands on a copy of the form “Sell Direct® REQUEST” (PD F 5179-1, it’s the second to last form on the page) from this page of Treasury forms [7]. Sign the form in the presence of an “authorized certifying officer,” usually at a bank, and mail to:
Federal Reserve Bank of Chicago
Investment Division for Sell Direct
230 S. LaSalle St.
Chicago, IL 60604
At Chicago, the Federal Reserve Bank will sell your security to the highest bidder, deduct a $45 fee, and transfer the rest to your bank account.
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