2021: What Should I Do? Buy the Long Bond or Roll-over Treasury Bills?

01/11/2021 01:16 PM

The question posed in the title is one asked often by many sophisticated fixed income investors, both institutional and retail.  That is why it is so surprising that there are very few reviews of the historical results comparing rolling over short term investments versus buying a fixed rate bond. In this note we update our October 4, 2017 analysis of realized and “in progress” term premiums in the U.S. Treasury market through December 31, 2020.  On every single trading day since 1982, we compare the actual results from rolling over 6-month Treasury bills compared to buying Treasury bonds with maturities of 1, 2, 3, 5, 7, 10, 20, and 30 years. Because interest rates were declining for much of this period, we also report results for investments that are “in progress” and whose final outcome is still uncertain.

The magnitude of a “term premium” or risk premium in long term U.S. Treasury yields is a major focus of research by both academics and economists in the Federal Reserve System.  A recent paper by Canlin Li, Andrew Meldrum, and Marius Rodriguez summarizes two important papers on this topic and reviews their methodologies.  Adrian, Crump, Mills and Moench (2014) summarize their term premium findings as follows: “The evolution of term premia has been of particular interest since the Federal Reserve began large-scale asset purchases. Over this time, short-term interest rates have been close to zero, and our estimates show that the term premium has been compressed and has at times even been negative.” Estimates of the term premium are a function of the data used, the modeling approach taken, and market expectations.

The focus of this note is a simple one: the calculation of historical realized term premiums and “in progress” term premiums.  From the perspective of prudential regulation of financial institutions, Ramaswamy and Turner [2018] argue that interest rate risk may well be the trigger for the next financial crisis.  The magnitude of the term premium, both current and future, is an important element in assessing the interest rate risk of financial institutions.

A historical perspective on actual realized term premiums is also a potentially important contributor to market expectations, subject to the caveat stated by Robert A. Jarrow, “History is just one draw from a Monte Carlo simulation.”[1]

We seek to answer this question: “Which investment has provided the best total dollar return to investors, a U.S. Treasury bond maturing in X years or a money market fund that invests only in Treasury bills?”  We address the answer to that question with respect to U.S. Treasury fixed rate bonds with maturities of 1, 2, 3, 5, 7, 10, 20 and 30 years.  We remind readers that what follows is an analysis of history, not a forecast for the future.

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[1] Conversation with the author, 2015.