I recommended I-Bonds a while ago, highlighting the incredibly high yield in comparison to treasuries, and with the massive shift in inflation assessment and government bond yields, the gap has closed. So what is the better option? It is important to understand that both are guaranteed by the US government, and so are equally likely to default - that likelihood being near 0. I-bonds like I mentioned previously are limited to $10,000 per person per year, and are indexed to inflation + some fixed rate, which is adjusted to make them more competitive in the marketplace should inflation be incredibly low. Its rate is adjusted every 6 months. Alternatively, the traditional US Treasury Security is a fixed-term commitment ranging from 1 year to 30, and carries a fixed rate that is paid out over time, with the principal paid out upon the maturation of the loan - because that is what a bond effectively serves as, a loan. Both of these are very attractive fixed income options which allow people to get the closest thing to risk-free cash flow.
Investment firms and sophisticated investors sometimes hold them instead of cash because of the massive market for them, and thus their ridiculous liquidity. Given they pay a risk-free interest rate, it is much better than simply holding cash. The question is are they the right place for you to park your money.
The rise in interest rates has pushed the traditional treasuries higher, while the drop in Core CPI used to compute I-bonds has dropped. The difference between the two has dropped to 2.3% (4.6% 2yr treasury, 6.9% on I-bond). So the question is what governs these moves? Well, I-bonds are tied to inflation, and despite its hot run, likely to continue into 2023, it will eventually cool down substantially, leading the yields to run back to their normalized rate of 2-4%, lower than the normalized Treasuries at this yield. Similarly, although rates have a big impact on Treasuries (why would you let the government borrow at below the Fed rate for example), they are not tied to it other than through its influence over demand. This is why it is likely that if the Fed’s current hiking cycle is as predicted, the reality is already priced in. And, if there is substantial pullback on their end to help soften the blow to the economy or any such behavior, the yield could fall substantially. Additionally, it is important to consider that given normal Treasuries allow you to lock up the rate for a very long time, a 10 year gives you the opportunity to take advantage of elevated interest rates for the next decade… That’s exactly why the yield curve is inverted.
Treasury Yields over time
If you’re thinking about the decision of purchasing bonds, I would advise that there are many better options in the capital markets. Like my other articles have mentioned, stocks like Bank of Nova Scotia offer a higher yield (6.3%), while also giving the upside of strong cash flow, in a strong economy and industry, while also benefiting from the inevitable rebound in equities. At the same time, there is always risk in the stock market, regardless of the importance of the business, and so for those who are completely risk-averse they can be a good option. In this case, I would probably pick the normal 10 year because the difference short-term is small, and the marginal gain over the next 9 years will likely be much larger.
By: Mateo Gjinali