US Treasury Bonds: 3 Reasons To Consider Buying Them Now
US treasury bonds have been under pressure lately. The iShares 20 year+ treasury bond ETF (TLT) is down about 35% since the US Federal Reserve (Fed) started raising interest rates in March of 2022. TLT tracks the price of US treasury bonds – or American government bonds that take 20 to 30 years to mature. And here are 3 reasons why now could be a good time to add them to your portfolio.
What are US treasury bonds?
Put simply, US treasury bonds are loans from the American government. Investors can buy and sell these loans just like a stock. If you own a treasury bond, the US government owes you money. This comes in 2 forms:
- Coupons: interest payments every 6 months.
- Return of principal: the original value of the loan. Think of this like a deposit you get back at the end of the loan.
The value of longer-dated bonds (those with more years left to mature) is more sensitive to interest rate changes. With long-term bonds, you’re locking in a fixed coupon rate for a really long time. So if the interest rate you can get at the bank goes up, those coupons aren’t going to be worth as much. In other words, you’re sacrificing a lot more interest than you would with a short-term loan.
So with that primer out the way, here are 3 reasons why I like US treasury bonds right now.
Reason 1: US Treasury bond prices might be bottoming.
Just like with crypto, stocks, and other investments, you can use technical analysis to interpret the price action of US treasury bonds. And to do that, I’ve charted the iShares 20 year+ treasury bond ETF (TLT) below. As usual, I’m looking at the weekly chart to zoom out and focus on the long-term picture.
As the chart shows, the price of TLT has made a lower low over the past year – that’s usually bearish. But at the same time, the Relative Strength Index (RSI) is potentially making a higher low.
The RSI measures the relative strength of buy pressure vs. the relative strength of sell pressure. So even though the price is down, buyers are getting stronger relative to sellers, according to the indicator. In other words, the chart is showing potential RSI bullish divergence. This can be a sign that the tide might be turning for US treasury bond investors.
Of course, this divergence is only a “potential” right now. That’s because the price needs to first “confirm” a low before you can have divergence. That said, by zooming in and throwing some Bollinger Bands around the chart, there could be early signs that a low could be forming.
The chart below shows how the price behaved around the bottom Bollinger Band over the past 3 weeks (green circle). First, there was a red candle that ended the week below the bottom band – a sign of increased seller momentum. But then last week, TLT finished up strong – back above the bottom band. Essentially, buyers stepped in and abruptly stopped that seller momentum. A similar thing happened in the October 2022 low (white circle).
So long as TLT can hold above the bottom band, the bullish divergence looks more likely to play out. Given this divergence would be on the weekly timeframe, it would suggest TLT could slowly be finding a longer-term low.
Reason 2: US Treasury bonds pay a decent yield right now.
Even if prices dip lower from here, treasury bonds pay a yield of around 5% right now. You can think of bond yields like the rental yield on a property. If you buy a house for a lower price and get a fixed amount of rent, your rental yield is higher as a percentage of your purchase price. And regardless of what happens to the future sale price of the house, you’re still locking in that same rental yield as a percentage of what you paid for the house.
It’s the same with treasury bonds. If you buy them cheaper, your coupon payments give you a better yield based on what you paid for the bonds. Right now, bonds are cheap.
Side note: Exchange Traded Funds (ETFs), like TLT, pay out dividend yields to shareholders (since ETFs are traded like stocks). This dividend yield will typically be a bit less than the actual yield you’d get from buying a brand new treasury bond directly. This difference is mainly down to management fees, and the fact that ETFs hold lots of different bonds that expire at different times. It can also be influenced by the ETF trading at a premium or discount to what the underlying bonds are worth. You can learn more about bond math here.
Reason 3: The economy
It’s impossible to predict what the economy will do next – there are just too many variables to consider. But the bond market can give us early clues. Today’s bond prices represent the collective wisdom of what investors think will happen to the economy in the future.
Although there’s no hard and fast rule here, the bond market often leads the economy. So if more investors start buying treasury bonds now, we can get a glimpse into what the US economy might look like in the coming months and years.
Investors tend to buy treasury bonds if they think:
- Inflation will go lower. If investors think inflation will go down in the future, it makes sense for them to buy bonds now. That’s because the future value of their investment (coupons and return of principal) won’t be eroded as much by inflation.
- Interest rates will go lower. If investors think interest rates will drop, the future value of bond coupon payments can also be more attractive vs. keeping money in the bank.
- Economic growth will slow down. Sadly, it’s not all good news. Lower inflation is often caused by a slowing economy or recession. Central banks usually lower interest rates at this point to speed the economy back up.
So, if you think inflation and interest rates could go down (along with economic growth), it makes perfect sense to own treasury bonds in your portfolio.
How do you buy US treasury bonds?
If you’re based in the US, research the iShares 20 year+ treasury bond ETF (TLT, expense ratio: 0.15%). And if you’re across the pond in the UK (like me), check out the iShares $ Treasury Bond 20+year UCITS ETF on Hargreaves Lansdown.
Key Takeaways
- US treasury bonds are essentially loans to the US government. When you buy them, the US government owes you money.
- There’s potential RSI bullish divergence on the weekly chart for TLT, which tracks the price of a basket of US treasury bonds with maturities of 20 to 30 years.
- US treasury bonds haven’t had the best year, but the yields are good at these prices.
