Don't Believe Everything You Read About Treasuries

| About: iShares 20+ (TLT)

On Wednesday, under the "Top News" section of Seeking Alpha's homepage was the headline, "Losses come quick for Treasury investors." Upon clicking on the headline, investors were brought to a brief paragraph mentioning the recent rise in the 10-year Treasury (NYSEARCA:IEF) that then claimed that a further 50 basis point rise in yield would result in a 6.78% loss in principal. The 6.78% loss figure came from a tweet by a corporate CIO. For those investors interested in reading the tweet, click here.

Before continuing on, let me state clearly that I do not think Treasuries (NYSEARCA:TLT) are a buy at these yields. I can think of plenty of other things I'd rather do with new money ready to be invested in the markets than purchase a 10-year Treasury yielding 1.809% on a non-taxable-equivalent yield basis. For those investors confused about why I noted that the 1.809% yield is on a non-taxable-equivalent yield basis, you may find my article, "One Thing You Might Not Know About Treasuries," informative.

Just because I wouldn't put new money to work at these levels doesn't mean I'm not interested in the truth. Therefore, I'd like to provide investors with a more complete and accurate examination of what would happen if there were a further 50 basis point rise in the 10-year Treasury note maturing 8/15/2022, CUSIP 912828TJ9.

First, when talking about how much you would "lose" in unrealized mark-to-market movements on a Treasury note, it's important to talk about what the time frame is. If the time frame is anything beyond immediate, then you must factor in the steepness of the yield curve. Let's first assume the CIO tweeting about a 6.78% loss is referring to an immediate jump of 50 basis points. Based on the price of that note at the time this article was written and assuming the jump of 50 basis points happens immediately, the loss on the note would be about 4.41 points. This equates to an unrealized loss of about 4.48%, not 6.78%. You can use a price/yield calculator to do this calculation for yourself. If you don't have access to that tool, call your broker, and a bond representative should be able to give you this information.

If you have access to a price/yield calculator, here's the information you would need to do the calculation. You want to calculate what the bid would be (the price at which you could sell) today if the yield on the 10-year Treasury, CUSIP 912828TJ9, were 50 basis points higher at 2.309%. You would type into the calculator 2.309% as the yield-to-maturity, the current coupon of the note (1.625%), the coupon frequency (semi-annual), the maturity date (8/15/2022), and the settlement date (one day settlement on Treasuries). The price the calculator gives you (currently 93.92) should be compared to the current asking price (price at which you buy) of 98.328125. Take the difference between the two and divide that number by the current asking price. The result is a loss of about 4.48%.

Next, let's assume the loss happens over time. Based on the shape of the yield curve as it stands today, over the next three months, that Treasury note will move a bit more than three basis points down the yield curve. Over the next six months, it will move about eight basis points down the yield curve.

How long will it take to move about 50 basis points down the yield curve assuming no change to the steepness of the yield curve? It will take about two-and-a-half years. This means that if the 50 basis point move happens over the next two-and-a-half years, you will break even on an unrealized capital gains basis, and you will collect your coupon on top of that. If the loss happens before the two-and-a-half years, the 50 basis point move in the 10-year will affect you less and less as your 10-year becomes a 9.75 year, then a 9.5 year, etc., working its way down the yield curve. After all, if you buy a 10-year today, six months from now, it doesn't matter what a 10-year is trading at. Instead, it matters what a 9.5-year is trading at. My article, "Trading the Yield Curve," goes into more detail about this.

Finally, we need to think about what type of change to the steepness of the yield curve may occur between now and two-and-a-half years from now. With the Fed stating it will keep the short end of the curve near zero through late 2014, we can assume the front end of the Treasury curve will remain ultra-low for the next two-and-a-half years. Therefore, any move higher in the longer parts of the Treasury curve will, more likely than not, cause a steepening in the Treasury yield curve rather than a narrowing. This means that it is more likely than not that as the 10-year Treasury note moves its way down the yield curve over the next two-and-a-half years, any rise in its yield will be met with a rise in the number of basis points per month investors can expect from riding the yield curve (as explained in the article linked above).

With the incredible amounts of news and information thrown at investors on a daily basis, it can be challenging to sift through it all, separating useful information from mis-information. Despite the fact that I have no interest in purchasing more Treasuries at these levels (I do hold some), I think it's important that investors who may feel differently from me are given accurate and complete information about those securities. In my opinion, this is also important information for anyone interested in bonds to understand, even those investing through bond ETFs such as the iShares Barclays Aggregate Bond Fund (NYSEARCA:AGG), the iShares iBoxx $ Investment Grade Corporate Bond Fund (NYSEARCA:LQD), or the iShares iBoxx$ High Yield Corporate Bond Fund (NYSEARCA:HYG).

Disclosure: I am long HYG.

Additional disclosure: I am also long Treasuries