Should One Invest In Treasury Bills

Bill Gross, former “bond king” has gotten back into the news recently with a modest picture of what might be in store for investors.

His conclusion: buy U.S. Treasury bills.

Buying one-year Treasury bills will give you a yield of right around 3.00 percent and protect you in the risk arena.

The thing that sets his whole reasoning off is the fact that he believes that there is a massive misallocation of capital in the financial markets, arising especially from the Federal Reserve’s efforts over the past three or four years to pump liquidity into the banking system and avoid a financial collapse connected in time with the Covid-19 pandemic.

In this aspect of his argument, I couldn’t be in more agreement.

Over the past year or so, I have written numerous posts about the misallocation occurring in the banking system and financial markets.

We saw this misallocation popping up all over the place, in blank check companies (Special Purpose Asset Companies or SPACs), in private asset allocation, and in Bitcoin. There are, of course, many other areas.

Just in the Bitcoin (BTC-USD) area, we saw a movement in total capital valuation running from about $1.0 trillion in 2019, to $3.2 trillion in November 2021, to less than $1.0 trillion just recently.

And, this misallocation runs internationally.

Inflation Hits

Then we find inflation hitting, with the Federal Reserve pushing off dealing with the rise in prices for at least nine months, if not longer.

Inflation is now running at a 40-year high and finally, the Federal Reserve is doing something about it.

Or, at least they are talking about how they are doing something about it.

However, there are funny things going on in the financial markets, things that make you question what we are in store for.

For example, the inflationary expectations built into Treasury yields are not showing much fear of inflation, at all.

For example, when we subtract the yield on an inflation-protected U.S. Treasury security from the nominal yield earned on a U.S. Treasury security of similar maturity we get an estimate of the inflationary expectations built into the market yield.

Right now, expected inflation for the next ten years comes out to be about 2.6 percent.

For the next five years, inflationary expectations come in at about 2.3 percent.

There is hardly any inflation built into bond yields at all.

How do these rates compare with currently announced inflation? Not too well.

Yet, these expectations come in much closer to the projections of interest rates provided by the Federal Open Market Committee of the Federal Reserve.

These projections, just released at the latest meeting of the FOMC in June, show that the Fed expects, inflation to be 5.2 percent in 2022, 2.6 percent in 2023, 2.2 percent in 2024, and 2.0 percent over the longer term.

So, the inflationary expectations built into Treasury market yields seem to be relatively consistent with Federal Reserve projections, and not with the projections of analysts more concerned with the possibility that inflation might get out of hand.

So, the Fed says it is going to control inflation and the financial markets seem to reflect the fact that the Fed will actually do what it says it is going to do.

Fed Raising Rates

But, now the Federal Reserve is in the game of raising its policy rate of interest.

The Fed shook up the financial markets in June as it raised its policy rate of interest by 75 basis points.

Right now, investors appear to believe that the Fed will raise its policy rate by another 75 basis points in July.

That will take the upper limit to the Fed’s target range to 2.50 percent.

Many believe that by the end of 2022, the upper limit will rise to 3.5 percent.

This seems to be where a lot of investors believe the policy rate of interest will go.

That is only modestly above where the yield on the 30-year U.S. Treasury security is right now.

The question here is that, given this picture, the term structure of interest rates will hardly be negatively sloped. Right now, only the longer maturities on the term structure curve possess any kind of negative slope and the “curve” in the longer-term securities is basically flat.

Historically, as the Federal Reserve tightens up on monetary policy by raising its policy rate of interest, the term structure becomes downward sloping from the very short-term maturities to the longer-term maturities.

We are a long way from that, with no indication from the Fed that the term structure of interest rates will actually turn negative.

Other Markets

It is further expected that the stock market will close lower going forward as the Fed moves its policy rate of interest upward and as the economy slows down.

How far will the stock market drop?

Will, seemingly, that will depend upon how fast the Fed raises its policy rate of interest and how fast the economy slows down impacting profits.

If we get a “soft landing” then the decline will not be too major.

However, there are forecasts that the upcoming recession might not be so “soft.” If this is the case, then the expectations are for the Fed to jump right into the fray and fight to keep stock prices from falling too much.

Fed projections for future growth of real GDP?

For 2022, the Fed expects real GDP to rise by 1.7 percent. For 2023, the rise is expected to be 1.7 percent, followed by 1.9 percent in 2024 and then 1.8 percent for the longer term.

In other words, the Fed is expecting economic growth is continue but will remain below historical standards. This is more of a picture of stagflation.

As far as bond rates are concerned, higher rates are in store for a while, so bond prices will be declining over the next year or so.

Capital losses.

Conclusion

So, stay short, stay out of stocks, and be nimble.

The real danger comes from the cloud that hangs over all the markets, the assumptions that are built into the initial framework: the misallocation of capital.

The feeling is that this misallocation of capital is “massive.”

The term comes from Bill Gross, but I concur with him on this.

This is the ominous part of the picture.

If the misallocation has to be corrected, it will cause pain, cause a substantial disruption of business, and take time to recover.

But, the correction of the misallocation is part of the radical uncertainty that exists at this time.

This massive “black cloud” is out there. But, the economy and the financial markets must continue to plug along. The Federal Reserve must continue to fight inflation.

How much is too little? And, how much is too much?