T-Bills, Again

by: WWS Swiss Financial Consulting SA
Summary

Fixed income.

Follow the "smart money"

Strategic investment with T-bills.

Many investors, including those that concentrate on stocks, know that an inverted yield curve is a signal that a recession is likely to follow in the next nine to twelve months. So they may position their portfolios accordingly. There has been so much written recently about the inverted yield curve and the expectations of a recession in the next nine to twelve months that one has to take this possibility under consideration.

A flattening yield curve and an inverted yield curve indicate that investors are opting to buy longer-term Treasuries as opposed to shorter-term Treasuries because they think that the Fed is going to lower rates. The demand for the longer-term security raises the price and hence results in a lower yield. The Fed has increased the Federal funds rate several times since 2016, and the effective Fed funds rate is now 2.41%. This means that shorter-term securities now yield about 2.43% (13 week T-bills), which is a lot more than they were yielding early in 2016 when the Federal funds rate was near zero.

“Smart money” means the money of smart people, and if smart people are moving capital into longer-term Treasuries there will be a reason for it. One reason is that the risk of holding government paper is fairly low while equities carry with them a lot of potential downside risk. Given that the first three months of 2019 have seen important advances in the stock market, it is likely that there will not be great gains in the course of the rest of the year if past performance of markets is any indication of how markets develop over the rest of the year when the first quarter is very positive. So investors could seek out a lower-risk investment that offers a good margin of safety.

The 10-year Treasury note now yields 2.4%.

St Louis Fed

The choice of 10s (10-year Treasury notes) is not an accident as the 10-year note is taken as the benchmark for the market. Recently the yield curve of the 10-year note and the 3-month T-bill inverted, and this has been seen as an important signal of an approaching recession. See above.

St Louis Fed 10-year minus 3-month

It might seem advisable for an investor to go for 3-month T-bills rather than 10-year notes as the T-bills have a higher yield at the moment, but the market is anticipating that the Fed is going to lower rates in the future rather than continue with a series of rate hikes. In that case the yields for shorter-term bills will decrease while the 10-year notes will continue to produce a higher yield. It may well be the case that investors would do well to follow the “smart money” and move into longer-term Treasuries when their T-bills mature. It would also be prudent to increase fixed-income holdings in one`s portfolio and decrease exposure to equities as the prices for stocks are still relatively high. This is even more pertinent as the expectations for further gains in 2019 are limited.

As the Fed has recently reversed its former hawkish hard-liner policy and adopted a dovish stance, namely, postponing rate increases and curtailing QT (Quantitative Tightening, which means reducing its balance), a decrease in rates is highly probable. It is also highly likely that the huge federal deficits may result in an increase in the Fed`s balance. So much for the FOMC`s good intentions to prepare for a recession by raising rates so that rates could be lowered in case of need. As Robert Burns so aptly wrote, “The best-laid schemes o`mice an` men Gang aft agley, An` lea`e us nought but grief an` pain”. So be it with the Fed.

It therefore remains to evaluate to what extent continuing to hold T-bills in such an environment is a reasonable investment plan to implement. See the figures below.

4 WEEKS 8 WEEKS 13 WEEKS 26 WEEKS 52 WEEKS
DATE BANK DISCOUNT COUPON EQUIVALENT BANK DISCOUNT COUPON EQUIVALENT BANK DISCOUNT COUPON EQUIVALENT BANK DISCOUNT COUPON EQUIVALENT BANK DISCOUNT COUPON EQUIVALENT
03/01/19 2.40 2.44 2.41 2.46 2.39 2.44 2.45 2.51 2.47 2.55
03/04/19 2.40 2.44 2.41 2.46 2.41 2.47 2.47 2.54 2.46 2.54
03/05/19 2.39 2.43 2.40 2.45 2.41 2.47 2.46 2.53 2.46 2.54
03/06/19 2.38 2.42 2.39 2.44 2.41 2.47 2.46 2.53 2.46 2.54
03/07/19 2.41 2.45 2.41 2.46 2.40 2.45 2.45 2.52 2.44 2.52
03/08/19 2.41 2.45 2.41 2.46 2.41 2.46 2.45 2.52 2.45 2.53
03/11/19 2.40 2.44 2.40 2.45 2.41 2.47 2.47 2.54 2.45 2.53
03/12/19 2.39 2.43 2.41 2.46 2.41 2.47 2.46 2.53 2.44 2.52
03/13/19 2.39 2.43 2.39 2.44 2.40 2.45 2.46 2.53 2.45 2.53
03/14/19 2.43 2.48 2.41 2.46 2.40 2.45 2.45 2.52 2.44 2.52
03/15/19 2.42 2.46 2.41 2.46 2.40 2.45 2.45 2.52 2.44 2.52
03/18/19 2.43 2.48 2.41 2.46 2.39 2.44 2.44 2.51 2.44 2.52
03/19/19 2.41 2.45 2.42 2.47 2.41 2.47 2.45 2.52 2.42 2.50
03/20/19 2.41 2.45 2.40 2.45 2.42 2.48 2.42 2.49 2.40 2.48
03/21/19 2.46 2.51 2.42 2.47 2.43 2.49 2.43 2.50 2.41 2.49
03/22/19 2.44 2.49 2.43 2.48 2.41 2.46 2.41 2.48 2.38 2.45
03/25/19 2.42 2.46 2.42 2.47 2.41 2.47 2.42 2.49 2.35 2.42
03/26/19 2.42 2.46 2.39 2.44 2.41 2.47 2.42 2.49 2.36 2.44
03/27/19 2.41 2.45 2.38 2.43 2.39 2.44 2.39 2.46 2.32 2.40
03/28/19 2.40 2.44 2.40 2.45 2.38 2.43 2.37 2.44 2.32 2.40
03/29/19 2.39 2.43 2.39 2.44 2.35 2.40 2.37 2.44 2.32 2.40

Friday Mar 29, 2019

One can clearly see that short-term T-bills are a good fixed-income investment. It is therefore a reasonable investment plan to allocate some capital to T-bills at the moment since the Fed will probably not start lowering interest rates until a recession sets in, and that is unlikely before nine months to a year even if most of the economic data is pointing downwards. At the very least, in this case, one would be protected from the downside risk of equities.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: "Cavest emptor". Investors assume full responsibility for their investment decisions.