Should you buy the 10-Year Treasury Bond now?

Ten-year Treasury bonds currently yield about 4.25%, a desirable rate compared with the low of .55% in August 2020. Nevertheless, it would be best if you did not buy it.

The chart below shows how abnormally low .55% is in the history of the ten-year yield since the 1960s. Moreover, the current 4.25% yield on the ten-year is also relatively low, almost two percentage points less than the annual average of 6.05% between 1960 and 2020. A much better investment in government securities is the one-year Treasury bill that yields about 5.35%.

Most investors believe that future short-term rates will be lower than today as the Federal Reserve reduces its target interest rates. They point out that investing at 5.35% for one year and reinvesting after that will yield less than 5.35%. But there are at least three reasons to suspect that future short-term rates might not be that much lower than today and could even be higher.

Here they are:

1. The Federal Reserve will reduce rates going forward only if inflation continues to decline towards its 2% target, which is certainly not guaranteed. If inflation heats up or fails to decline, the Fed will raise short-term rates rather than reduce them.

2. The government budget deficit stands at 6% of Gross Domestic Product, far higher than is normal for a peacetime, fully-employed economy, and that means more bonds must be issued going forward, requiring higher yields to attract new investors.

3. The Federal Reserve has committed to reducing its massive holdings of government bonds, adding to the supply private investors need to buy, pushing up rates.

The current relationship, where one-year yields are 5.35% and ten-year yields are 4.25%, is unusual. Under most circumstances, ten-year yields are higher than one-year yields to reflect the more significant price volatility of long-term bonds. That normal relationship can be restored by a decline in short-term rates, an increase in long-term rates, or a combination of the two. Do not be surprised, therefore, if the rate on ten-year Treasuries rises rather than declines going forward.

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