2-Year Treasury Auction Sets Up Great Opportunity for Advisors

Tuesday’s regular auction of two-year U.S. Treasury notes produced yet another instance of “the highest yield since.” 

This time, the date was Dec. 29, 2000. So, it has been nearly 23 years since advisors could allocate a portion of client portfolios to an investment that, barring financial Armageddon, should deliver more than a 5% return for the next two years. By comparison, exactly two years ago, the two-year Treasury note boasted a big fat yield of…wait for it…0.31%. 

This has many implications for advisors. The only question is, if they are not using this “free lunch,” in portfolios, or at least talking to clients about it, is “why not!?” 

Sure, inflation is high and may even reaccelerate. But not all investors are as religious about “real yield” when they can solve one financial problem: That 5% is better than zero, which is about the same return the S&P 500 has delivered the past two years. As advisors know, fighting inflation is one thing, earning a positive return in nominal terms is another.  

And depending on the client, one may override the other. But at the very least, at 5% for two years, the conversation should be on the table. When rates reached the 5% mark on one-month and three-month T-bills, it was less of a slam-dunk discussion with clients. But now that investors can have the confidence that some portion of their portfolio is going to make 5% return for the next two years through the presidential elections, through developments with inflation, credit card debt, student loan repayments, the U.S.’ more than $30 trillion in debt and a host of geopolitical issues, it is hard to ignore the relative certainty of two years of 5% return. 

High Yield With Possible Fed Rate Cuts 

When rates have risen by this much so quickly, even shorter-term bonds like a two-year U.S. Treasury note can offer additional perks. One of the primary bullish narratives right now is that the Federal Reserve will cut rates early next year. While Fed Chairman Jerome Powell threw cold water on that scenario during his last press conference, there still exists the possibility that sometime in 2024, or even before the end of 2023, rates could come down.  

And, while that will likely be due to some very bad turns in the economy, prompting relief from the Fed, it would provide another opportunity for those investors who will forsake the rest of their 5% yield and instead cash in bond profits as those rates fall.  

Past Treasury ETFs Offer a Lesson 

This was the case in early 2020, when ETFs that track this part of the U.S. Treasury yield curve offered a rare opportunity for capital appreciation, rather than just their income return. 

In fact, from June 17, 2007, through March 17, 2008, a period of nine months, the two-year Treasury yield dropped from just under 5% all the way down to 1.35%, as the Global Financial Crisis hit. During that period, iShares 1-3 Year Treasury Bond ETF (SHY) earned an unannualized total return of 9.1%, of which 5.9% came from price appreciation. The SPDR S&P 500 ETF Trust (SPY) fell 15.3% during that time. So, there is historical precedent for an owner of an allegedly boring class of ETFs to be stars of an advisor’s portfolio, at the worst of times for other investors.  

Tuesday’s two-year U.S. Treasury note auction is a fresh reminder of how short-term bonds are historically attractive to many. And while earlier this year those 5% rates were only able to be had for months, now it's going to years. That’s at least worth noticing for many advisors and their clients.