4-week T-bills
April 12, 2007 9:48 AM Subscribe
What factors influence the value of 4-week T-bills in the United States?
I am more or less a total novice in matters of investment, but I've just decided to do something with the money I have lying idle in my savings account. So I've set up a T-bill ladder, buying a 4-week T-bill once every two weeks with the intent of purchasing another whenever I receive the return on a previous one.
Currently the investment rate of a 4-week T-bill hovers around 5%, much better than my savings account. But this chart (the best I could find with Google) seems to indicate that over time the return on a T-bill has historically varied between 1% and 12%. (Those figures are for 6-month T-bills, but I'm assuming that 4-week T-bills perform similarly to, though not the same as, 6-month T-bills over time.)
My Econ 101 question is: what factors (such as high or low unemployment figures, or increasing or decreasing interest rates) can make the value of T-bills go up or down over time for the individual investor? I'll get this information eventually by reading about the bond markets every week, I suppose, but I'm hoping someone with more experience can give me some answers.
I am more or less a total novice in matters of investment, but I've just decided to do something with the money I have lying idle in my savings account. So I've set up a T-bill ladder, buying a 4-week T-bill once every two weeks with the intent of purchasing another whenever I receive the return on a previous one.
Currently the investment rate of a 4-week T-bill hovers around 5%, much better than my savings account. But this chart (the best I could find with Google) seems to indicate that over time the return on a T-bill has historically varied between 1% and 12%. (Those figures are for 6-month T-bills, but I'm assuming that 4-week T-bills perform similarly to, though not the same as, 6-month T-bills over time.)
My Econ 101 question is: what factors (such as high or low unemployment figures, or increasing or decreasing interest rates) can make the value of T-bills go up or down over time for the individual investor? I'll get this information eventually by reading about the bond markets every week, I suppose, but I'm hoping someone with more experience can give me some answers.
At the risk of greatly oversimplifying things, in general the yield on short maturity instruments is set by Federal policymakers, and the yield on longer maturity instruments is mostly set by market participants (though the Fed theoretically can and does impose its will on the longer end through open market operations).
The value of your T-bills will not usually substantially change, as short-term paper is very short-duration, and isn't meaningfully interest-rate sensitive. The yield that you will get on new bills is (as I stated) more or less set by the Fed. Generally, the interest rates on t-bills increase when the Fed thinks that the economy is overheating-- when inflation is high and unemployment is low.
posted by Kwantsar at 12:10 PM on April 12, 2007
The value of your T-bills will not usually substantially change, as short-term paper is very short-duration, and isn't meaningfully interest-rate sensitive. The yield that you will get on new bills is (as I stated) more or less set by the Fed. Generally, the interest rates on t-bills increase when the Fed thinks that the economy is overheating-- when inflation is high and unemployment is low.
posted by Kwantsar at 12:10 PM on April 12, 2007
the official equation (at least according to the finance class I took is k=k*+IP+DRP+LP+MRP
where
k = the quoted rate of the security
k* = real risk free rate of the security (if there were no risk with no inflation)
ip = inflation premium (the
drp = default risk premium - the risk that issuer will not pay
lp = liquidity premium - how easy it is to convert the security to cash
mrp = maturity risk premium - a premium reflecting the possibility that the price of the bond might decrease.
However, T bills are generally assumed to have a 0 or almost 0 drp and lp.
posted by jourman2 at 12:12 PM on April 12, 2007
where
k = the quoted rate of the security
k* = real risk free rate of the security (if there were no risk with no inflation)
ip = inflation premium (the
drp = default risk premium - the risk that issuer will not pay
lp = liquidity premium - how easy it is to convert the security to cash
mrp = maturity risk premium - a premium reflecting the possibility that the price of the bond might decrease.
However, T bills are generally assumed to have a 0 or almost 0 drp and lp.
posted by jourman2 at 12:12 PM on April 12, 2007
To further explain, the reason that your T-bill's value won't really go down is that the investment lasts for only 4 weeks.
In simple terms: You buy a 5% t-bill, rates go up to 10%, you get your money back in a month, and buy a 10% t-bill. You can imagine why this would be more problematic if you didn't get your investment back for 30 years.
The consequence of this is that you know exactly how much money you'll be getting in 4 weeks, and no matter what rates do, the rapid return of your investment will ensure that you can reinvest at higher rates if they occur.
So when you ask about the value of T-bills going up and down, you're asking the wrong question. What you want to know (I think) is what makes the rate of return on T-bills change.
posted by Kwantsar at 12:54 PM on April 12, 2007
In simple terms: You buy a 5% t-bill, rates go up to 10%, you get your money back in a month, and buy a 10% t-bill. You can imagine why this would be more problematic if you didn't get your investment back for 30 years.
The consequence of this is that you know exactly how much money you'll be getting in 4 weeks, and no matter what rates do, the rapid return of your investment will ensure that you can reinvest at higher rates if they occur.
So when you ask about the value of T-bills going up and down, you're asking the wrong question. What you want to know (I think) is what makes the rate of return on T-bills change.
posted by Kwantsar at 12:54 PM on April 12, 2007
They are the same, Kwantsar, Tbills are zero coupon instruments, so the only thing that changes is the purchase price, and the difference between purchase price and face is what makes you the money. Therefore, as price goes down, rate goes up.
That's the place to go.
posted by OldReliable at 1:41 PM on April 12, 2007
That's the place to go.
posted by OldReliable at 1:41 PM on April 12, 2007
No, Kwantsar has it right. He is making the case that because of the extremely short duration of 4-week t-bills, the prices of individual securities do not fluctuate much, BUT rates of return will differ with new issuances. Thus, the real question is what accounts for the changes in rates of return between issuances of 4-week t-bills.
posted by mullacc at 3:16 PM on April 12, 2007
posted by mullacc at 3:16 PM on April 12, 2007
I'm with Kwantsar - it doesn't make much difference to you as you're reinvesting and holding to maturity. If market participants are right, then you should make the same over twelve months of re-investing in t-bills as a 1-year bond. Of course they're never right.
Variations in the rate will make a big difference to money market traders who are taking leveraged bets on the ups and downs over an hour / day / week.
And the answer to the "real question" is (expectations of) Fed monetary policy, which is linked to the real world by their responses to unemployment, inflation, and the whole caboodle (housing starts, etc).
Good for you by the way. T-bills have been a smart, low risk investment over the last ten years. They've performed as well as many securities with higher variances.
posted by TrashyRambo at 8:01 PM on April 12, 2007
Variations in the rate will make a big difference to money market traders who are taking leveraged bets on the ups and downs over an hour / day / week.
And the answer to the "real question" is (expectations of) Fed monetary policy, which is linked to the real world by their responses to unemployment, inflation, and the whole caboodle (housing starts, etc).
Good for you by the way. T-bills have been a smart, low risk investment over the last ten years. They've performed as well as many securities with higher variances.
posted by TrashyRambo at 8:01 PM on April 12, 2007
Best answer: As has been pointed out, as you are holding the T-bill to maturity, you know exactly what your return will be over the period. Short of the US government going bust, the return to you of the T-Bill is fixed.
T-Bill rates are driven by the Fed funds rate, as determined by the Federal Reserve Open Markets Committee, which sets the rate monthly. The T-Bill rate should be equal to what the market believes the average Fed funds rate will be over the period. For a 4 week T-Bill, where the 4 weeks runs over a meeting, this means the T-Bill rate will be the average of today's rate, and whatever the market believes the rate will be moved to at the next meeting.
So what makes the Fed move rates? The primary goal of the Fed is to maximise growth while maintaining a stable and low rate of inflation. Very simply, low interest rates make the economy grow a bit faster, by providing easier credit, and higher interest rates slow it down. If the economy grows too fast, then inflation may take hold, which would be bad for the economy in the long term. On the other hand if the economy slows too much, then thats bad too.
Unlike other central banks, the federal reserve does not have an explicit inflation target. However, for comparison, the Bank of England aims for 2% inflation (plus or minus 1%), and the European Central Bank for below 2%. If the Fed believed that inflation was going to stay much above 3%, I think they'd be concerned.
So the things that affect the Fed funds rate, and hence T-Bills, are any indicators that tell you anything about future growth rates and inflation levels. Potentially an enormous area, but the key indicators would probably include:
The present rate of inflation and its trend. I believe the Fed favours the GDP deflator as a measure of inflation.
Indictors of inflationary pressure throughout the chain. So labour supply/demand - wage inflation, unemployment. Producer prices, raw material prices.
The growth rate of GDP and its trend.
Forward looking indicators of Business activity, through various surveys. The Purchasing Managers Index is well followed.
Forward looking indicators of consumer activity. University of Michigan consumer confidence survey is well followed. Housing starts and permits are also indicators of perceived consumer optimism.
Durable goods orders. (a very volatile series)
Supply of credit. Loan origination.
To some extent supply of money, although this approach has less popularity than it once did.
Productivity growth. If the productivity growth is high, the economy can grow faster without inflation.
A couple of final points.
The reason interest rates where much higher in the past was the higher rate of inflation. In order to slow the economy, and therefore reduce inflation, interest rates must be higher than inflation.
Secondly, be aware of the yield curve. Back at the beginning of the decade, the Fed Funds rate was very low. This was in order to offset the effect of the tech crash, amongst other things. However no one believed that they would stay at this level, so longer term interest rates were higher. This is known as an upward sloping yield curve - short term rates are lower than long term.
At the moment, short term rates are slightly higher than long term rates, as the market believes that the fed is unlikely to raise rates much further. Yield curve is slightly downward sloping.
My point is that T-Bills may be more or less advantageous, relative to other longer term bonds, depending on present views about interest rates over the long term, and whether those views are right.
Hope that's about the right level of explanation
Good luck.
posted by Touchstone at 3:33 AM on April 13, 2007
T-Bill rates are driven by the Fed funds rate, as determined by the Federal Reserve Open Markets Committee, which sets the rate monthly. The T-Bill rate should be equal to what the market believes the average Fed funds rate will be over the period. For a 4 week T-Bill, where the 4 weeks runs over a meeting, this means the T-Bill rate will be the average of today's rate, and whatever the market believes the rate will be moved to at the next meeting.
So what makes the Fed move rates? The primary goal of the Fed is to maximise growth while maintaining a stable and low rate of inflation. Very simply, low interest rates make the economy grow a bit faster, by providing easier credit, and higher interest rates slow it down. If the economy grows too fast, then inflation may take hold, which would be bad for the economy in the long term. On the other hand if the economy slows too much, then thats bad too.
Unlike other central banks, the federal reserve does not have an explicit inflation target. However, for comparison, the Bank of England aims for 2% inflation (plus or minus 1%), and the European Central Bank for below 2%. If the Fed believed that inflation was going to stay much above 3%, I think they'd be concerned.
So the things that affect the Fed funds rate, and hence T-Bills, are any indicators that tell you anything about future growth rates and inflation levels. Potentially an enormous area, but the key indicators would probably include:
The present rate of inflation and its trend. I believe the Fed favours the GDP deflator as a measure of inflation.
Indictors of inflationary pressure throughout the chain. So labour supply/demand - wage inflation, unemployment. Producer prices, raw material prices.
The growth rate of GDP and its trend.
Forward looking indicators of Business activity, through various surveys. The Purchasing Managers Index is well followed.
Forward looking indicators of consumer activity. University of Michigan consumer confidence survey is well followed. Housing starts and permits are also indicators of perceived consumer optimism.
Durable goods orders. (a very volatile series)
Supply of credit. Loan origination.
To some extent supply of money, although this approach has less popularity than it once did.
Productivity growth. If the productivity growth is high, the economy can grow faster without inflation.
A couple of final points.
The reason interest rates where much higher in the past was the higher rate of inflation. In order to slow the economy, and therefore reduce inflation, interest rates must be higher than inflation.
Secondly, be aware of the yield curve. Back at the beginning of the decade, the Fed Funds rate was very low. This was in order to offset the effect of the tech crash, amongst other things. However no one believed that they would stay at this level, so longer term interest rates were higher. This is known as an upward sloping yield curve - short term rates are lower than long term.
At the moment, short term rates are slightly higher than long term rates, as the market believes that the fed is unlikely to raise rates much further. Yield curve is slightly downward sloping.
My point is that T-Bills may be more or less advantageous, relative to other longer term bonds, depending on present views about interest rates over the long term, and whether those views are right.
Hope that's about the right level of explanation
Good luck.
posted by Touchstone at 3:33 AM on April 13, 2007
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most people are in treasury instruments because they fear exposure to equities. when their greed finally overcomes their fear, then they buy stocks.
posted by bruce at 11:19 AM on April 12, 2007