Treasuries

U.S. Treasuries are debt instruments issued by the United States Department of the Treasury to fund government expenditures and obligations. They are backed by the full faith and credit of the U.S. government, which makes them a secure and favored investment. Due to their low credit or default risk, they typically provide lower yields compared to other bonds.

Types of U.S. Treasury debt include:

• Treasury Bills (T-bills): Short-term securities that mature in a range from a few days to 52 weeks.
• Treasury Notes (T-notes): Longer-term securities with maturities of up to ten years.
• Treasury Bonds (T-bonds): Long-term securities that usually mature in 30 years and pay interest every six months.
• TIPS (Treasury Inflation-Protected Securities): Notes and bonds with principal amounts adjusted according to changes in the Consumer Price Index. TIPS pay interest semi-annually and are available in maturities of five, ten, and 30 years.

Newly issued Treasuries can be acquired at government auctions, while previously issued bonds are available on the secondary market.

Credit quality: Treasury securities are regarded as high-quality credit instruments, supported by the full faith and credit of the U.S. government. This backing is significant due to the federal government’s taxing authority and the overall strength of the U.S. economy. However, in August 2011, the long-term sovereign credit rating of the United States was downgraded from AAA to AA+ by Standard & Poor’s, reflecting growing concerns about the U.S. budget deficit and its future outlook.

Tax advantages: Interest income from Treasury bonds is exempt from state and local income taxes but is subject to federal income taxes. Other components of your return may be taxable upon the sale or maturity of the bonds. If you purchase a bond at a discount on the secondary market and either hold it until maturity or sell it for a profit, that gain will be subject to federal and state taxes. Buying a bond at market discount differs from purchasing a bond at Original Issue Discount (OID). Gains from selling or maturing a bond bought at market discount are treated as capital gains, while OID gains are classified as income.

Liquidity: Treasuries are highly liquid, with large volumes traded daily by various institutions, foreign governments, and individual investors. Investors can buy bonds at regularly scheduled auctions or in the secondary market, which is one of the most actively traded markets globally. Treasury bills, notes, and bonds are available with active bids and offers, and the spreads (the difference between bid and offer prices) are among the narrowest in the bond market. However, investors should be cautious, as Treasury securities can be particularly volatile during significant economic data releases.

Choice: Treasuries are available in maturities ranging from 4 weeks to 30 years, with longer maturities typically offering higher coupons. They also come in various structures, including coupon-bearing Treasuries, zero-coupon Treasuries, and TIPS, which adjust their principal and returns based on changes in the consumer price index.

Lower yields: Treasury securities generally offer lower interest rates compared to other securities in exchange for reduced default or credit risk.

Interest rate risk: Treasuries are vulnerable to interest rate fluctuations, with volatility increasing as maturity approaches. Typically, as rates rise, prices fall.

Inflation risk: With relatively low yields, the income generated by Treasuries may not keep pace with inflation. This does not apply to TIPS.

Credit or default risk: Investors should be aware that all bonds carry default risk. Monitoring current events, the national debt-to-GDP ratio, Treasury yields, credit ratings, and the dollar's weaknesses can provide insights into rising default risk.

Coupon or No Coupon: Buyers of Treasury notes (with maturities from 1 to 10 years) and Treasury bonds (up to 30 years) receive interest payments, known as coupons, every six months. The coupon rate is fixed at issuance. In contrast, Treasury bills (with maturities of one year or less) and zero-coupon bonds do not provide regular coupon payments. Instead, they are sold at a discount to their face value, with investors receiving the full face value at maturity. These are referred to as Original Issue Discount (OID) bonds, where the difference between the discounted price at issuance and the face value at maturity represents the total interest paid in one lump sum.