Bond Markets in 5 Minutes or Less: Your Full Guide Today

Give us 5 minutes and this piece will give you a clear and concise understanding of current market dynamics, investment strategies, and how it applies to your wealth and portfolio decisions. But if you prefer to watch and listen instead of reading, here is a video audiogram summary (It’s actually right around 4 minutes, so you can reclaim a full minute). 

Where are Treasury Rates Given Fed Cut Delays?

Clearly the Fed has been thrown a major curve ball in 2024 with inflation (still too high) and with the strength of the US economy (still too strong, to the extent that that's even a thing). The good news? Treasury rates are still high, as a result: 

• Today's rates on Treasuries up to 10 years in maturity (The red dots in the graph below) are hovering higher than 75% of all observed rates going back to 2000, with one-year Treasuries even nudging near the 95th percentile at around 5.15%. 

• The 20- and 30-year rates are still well above the median themselves. While there is a lot of interest rate volatility for terms of 20 years and up, from an asset-liability standpoint, there have been worse times to try to immunize long-term dollar liabilities for yourself. 

To put it simply, the Treasury market has seen much leaner times.

Now, if you're a high-net-worth investor, you may want to consider holding Treasuries directly across various maturities. Why opt for this approach over holding Treasury bond funds? Simply put, direct holdings offer a clearer, more structured path to locking in rates and outcomes. This doesn't make Treasury bond funds “bad.” It just means that, if you can, holding Treasuries directly has positive attributes that are probably worth the trouble of trading single Treasury bonds.

What About Money Markets?

Currently, the yields on short-dated risk-free assets (short-dated Treasuries) can make money-market accounts attractive, particularly for those looking to park their funds tactically for a short while. However, there are a couple of reasons to be cautious. If your money market exposure extends beyond Treasuries, you introduce elements of credit risk and liquidity risk, particularly under crisis scenarios. Additionally, the tax treatment can quickly become less advantageous.

Another issue is that rates might come down quickly either because the market moves or because banks start pulling back on deposit rates. Remember the expression: Bank rates “rise like a feather, drop like a rock.” Inertia means that investors might stay in those money market funds well past the point of them being attractive.

We're already seeing this with high-yield savings accounts at well-established firms starting to offer lower interest rates than just a few months ago. Moreover, these accounts produce fully taxable income. Therefore, while money market funds can be attractive at this moment, there should be some caution associated with them. You will need to be intentional and proactive in revisiting these investments as rates change, particularly if rates start creeping down.

Going Beyond Treasuries

Navigating bond-land can sometimes feel like trying to find your way through a dense forest. Let's clear some of the underbrush and look at where we stand with different types of bonds — corporate bonds, munis, international sovereign debt, and beyond. Understanding the landscape can help you choose the right paths and avoid the pitfalls.

Corporate Bonds and Munis: Higher Yields Maybe, Higher Risks Probably…

Right now, credit spreads—the extra yield you get over Treasuries—are very tight. This means you're not being paid much extra for taking on the additional risk (default being the issue with lending to companies). For instance, high-quality corporate debt is offering yields that are historically low, hovering around the 1% mark above Treasuries. This makes corporate bonds a less attractive path (and higher tax path) right now, certainly relative to other times, as the risk may not be worth the reward. Check out how much “richer” (aka cheaper) high-yield bonds could get in a crisis, in the graph below (the right tail of the distribution goes for miles into higher spreads).

As an aside, municipal bonds are also not particularly attractive relative to Treasuries, especially at shorter maturities, even when accounting for tax treatments. They are less liquid under normal circumstances and become inferior in terms of liquidity and pricing during crises (munis can lose money while Treasuries make you money, as people think the world is ending – Check out March 2020 on the performance graph for the S&P Municipal bond index). These factors suggest that municipal bonds are not ideal for large sums of money, especially funds needed during times of stress or for tactical redeployment. Given all of these factors, it's tough to argue in favor of munis over Treasuries.

International sovereign debt can be appealing. Developed nations offer reasonable interest rates—though likely not as high as the US—but act as diversifiers both in currency (especially given a strong US dollar) and fiscal standing over the long run (hopefully long run…). Emerging market debt goes a step further, offering yield generation, currency diversification, and a hedge against unsustainable fiscal policies in the developed world at large.

If you want to dig deep, here is an interactive graph that compares various assets classes. The data are from Research Affiliates, as of end of April 2024. Hover the data points to see details on each asset class (Direct link here).

Ultimately, it all comes down to the specific conditions you face and your tolerance for risk—both near-term volatility and the psychological burden of stepping out of mainstream investments. Remember, each type of bond carries its own set of risks and rewards. By understanding these differences and aligning them with your personal investment goals and risk tolerance, you can choose the paths that will best help you navigate through a complex and ever-changing world towards the destination that you envision for your assets.

What about Bond Laddering?

At its core, bond laddering is about diversification and risk management. And as an approach, it can make a lot of sense. It doesn't mean that all rungs of the ladder must be the same size. By laddering tactically, you can create maturity profiles that align with your needs and preferences, allow for reinvestments over time, and manage interest-rate risk. 

Of course, the danger is that interest rates might come down, making reinvesting maturing principal less attractive. However, assuming rates will only go down is a one-sided view. It's reasonable to explore locking in certain rates for specific lengths of time and calibrate around your preferences, while being aware of absolute attractiveness and relative value. This is about combining investment analysis with behavioral factors (like regret risk).

Back to Washington, DC: I Bonds and TIPS (Treasury Inflation-Protected Securities)

I Bonds: A Financial Safety Net (with Limits)

Think of I Bonds as a sturdy umbrella in the unpredictable weather of inflation. These bonds are designed to protect your purchasing power. For lower to middle-income investors, I Bonds are akin to a financial life jacket, offering a risk-free method to safeguard critical savings against inflation, with the added flexibility of cashing out when needed without losing principal value (under most situations).

But… the U.S. government caps the amount you can purchase annually to $10,000 per person. This limit is a nod to the ‘free lunch’ concept in economics—I Bonds are in effect a government-subsidized savings vehicle and it's never wise to offer unlimited free lunches; otherwise, you end up feeding a larger crowd than expected! Hence, while I Bonds provide an excellent shield against inflation, they are not a one-size-fits-all solution, particularly for higher net-worth individuals looking to protect larger amounts of wealth.

TIPS: A Simple (but Imperfect) Inflation Hedge for the Long Haul

On the other hand, TIPS (Treasury Inflation-Protected Securities) are marketable securities like Treasury bills and bonds, with their principal adjusting over time based on realized CPI inflation. This provides significant inflation protection with well-structured investment risk, unlike other "real assets" such as certain equities, real estate, or commodities (which are unstructured relative to inflation, though possibly attractive for reasons we get into below). The tax treatment is not ideal (investors pay taxes on unrealized principal appreciation if held in taxable accounts) but this issue can be exaggerated in its practical magnitude. It's really about thinking through it from a tax planning standpoint.

Now, even mild inflation over 40-50 years can reduce true wealth and consumption power by 50% or more. For example, a million dollars in cash today could be worth about $225,000 in real terms if inflation runs at 3% per year for the next 50 years (or down more than 75% in purchasing power). Currently, TIPS yields are fairly attractive at around 2% above inflation for various time horizons, certainly relative to history (and the negative real yields we saw only a few years ago).

No question, TIPS are more complex and it's important to understand factors like the principal adjustment factor, especially if you are concerned about deflationary shocks (the opposite of inflation). However, here is the fundamental issue with TIPS: CPI inflation may not perfectly track personal consumption baskets. In fact there are reasons to be more than a little cynical that the US government would provide a reliable hedge against inflation (debasing a currency is a fundamental tool of national debt management going back to whenever we humans started issuing money and debt). And here the U.S. government is effectively double dealing, as it is in control of how CPI inflation is calculated, so we have to assume current and future benevolence on the part of the country toward its “inflation-protected” creditors… However, TIPS can be valuable portfolio building blocks and a benchmark for those with significant exposure to real wealth destruction over generations—common for high net worth and ultra-high net worth clients.

Conclusion

For high-net-worth individuals and seasoned investors, the insights shared here are designed to not only deepen your understanding but also to empower you to navigate these waters with greater confidence, based on your own circumstances. Whether you're adjusting your portfolio in response to an anticipated shift in interest rates, or exploring the benefits of different types of bonds, we hope that the knowledge you've gained today serves as a compass in the ever-evolving landscape of financial investments.

Each type of bond, whether it be Treasuries, corporate bonds, or international sovereign debt, represents a different path to pursuing your investment objectives when chosen wisely and aligned with your personal financial goals and risk tolerance.

Remember, you're never just investing in bonds (or whatever other asset for that matter)—you're investing towards realizing your vision: securing resources for the next generation, making a positive impact on your community, or building a robust legacy. Here's to making every investment decision an informed one, and to your achieving meaningful goals.

Disclaimer:

The information provided in this newsletter is for informational purposes only and does not constitute investment advice, a recommendation, or an offer to buy or sell any securities. The content is based on information available as of the date of publication and is subject to change without notice. Treussard Capital Management LLC does not guarantee the accuracy, completeness, or timeliness of the information provided. Investment Risks: Investing in securities, including bonds, involves risks, including the potential loss of principal. The value of investments can go down as well as up, and investors may not get back the amount originally invested. Past performance is not indicative of future results. The performance of bonds and other fixed-income securities is subject to interest rate risk, credit risk, and inflation risk, among other factors. Specific Investment Strategies: The investment strategies discussed, including holding Treasuries directly, money market accounts, corporate bonds, municipal bonds, international sovereign debt, bond laddering, I Bonds, and TIPS, may not be suitable for all investors. Individual circumstances, financial situations, and investment objectives vary, and readers should consult with their financial advisor to determine the appropriateness of any investment strategy. Tax Considerations: The tax implications of investing in different types of securities can vary. Investors should consult with their tax advisor to understand the specific tax consequences of their investments, including the taxation of interest income and capital gains. Forward-Looking Statements: Certain statements in this newsletter may be forward-looking and involve risks and uncertainties. These statements are based on current expectations and projections about future events and are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated. No Guarantees: Treussard Capital Management LLC does not provide any guarantees regarding the performance or outcomes of any investment strategy. All investments carry inherent risks, and there is no assurance that any investment will achieve its objectives. Consultation with Advisors: Readers are strongly encouraged to consult with their financial, tax, and legal advisors before making any investment decisions. This newsletter is not intended to replace professional advice tailored to individual circumstances. Regulatory Compliance: Treussard Capital Management LLC is a registered investment adviser. This newsletter is intended to comply with all applicable regulatory requirements. By reading this newsletter, you acknowledge and agree to the terms of this disclaimer.