With inflation obviously on the rise, any rational investor should be asking “How well do U.S. Treasury yields forecast inflation?” Why? If Treasury yields are poor indicators of future inflation, then no one should buy bonds. On the other hand, if Treasury yields are reasonably accurate in predicting actual inflation, there’s no reason not to buy bonds as part of a balanced equity and fixed income portfolio.
A related question is one often addressed by economists: how big is the “term premium” in the U.S. Treasury bond market. There are many forward-looking articles on that topic. It is surprising that there are very few reviews of the historical results comparing rolling over short-term investments versus buying a fixed rate bond. That calculation answers both the inflation question and the term premium question. If U.S. Treasury yields inaccurately reflect future inflation, then there should be many historical periods where the realized results from rolling over short-term Treasury bills exceed the return that an investor holding the matched-maturity long-term bonds would have received.
In this note we update our January 7, 2021 and October 4, 2017 analysis of realized and “in progress” term premiums in the U.S. Treasury market through June 30, 2021. 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.
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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