Understanding U.S. Treasury Yields and Investing Effectively

Investors seeking stable asset management are rapidly increasing their interest in U.S. Treasury bonds. Based on the creditworthiness of the U.S. government, U.S. Treasuries are regarded as the safest assets in the financial markets, offering low risk and excellent liquidity. In this article, we will systematically explore the basics of U.S. Treasuries and investment strategies, with a particular focus on considerations for Korean investors.

Basic Understanding of Bonds and U.S. Treasuries

Bonds are essentially borrowing agreements. Investors provide funds to the government or corporations and receive regular interest payments in return, with the principal repaid at maturity.

When a country lacks funds for fiscal operations, it issues bonds to raise capital. U.S. Treasury bonds issued by the U.S. Department of the Treasury are classified into three types.

Short-term Treasury(T-bill): Maturing in less than one year, these have minimal risk and high liquidity.

Medium-term Treasury(T-note): Maturing between 1 and 10 years.

Long-term Treasury(T-Bond): Fixed-rate products with maturities from 10 to 30 years.

In particular, the 10-year U.S. Treasury note functions as a global benchmark interest rate and influences the pricing of various financial products.

Understanding the Relationship Between Treasury Yields and Prices

Treasury yields and bond prices always move inversely. This is a key mechanism reflecting investor sentiment and market supply and demand.

Treasury yield(yield) is calculated by dividing the expected annual return by the purchase price. When demand for Treasuries increases, prices rise and yields fall; when demand decreases, prices fall and yields rise.

During economic uncertainty, investors flock to safe assets like Treasuries, making U.S. Treasury yields a major indicator of economic conditions.

Four Main Advantages of Investing in U.S. Treasuries

1. Highest Level of Safety

Backed by the U.S. government’s repayment guarantee, the risk of default is virtually nonexistent. It is a preferred safe haven for many institutional and individual investors during economic downturns.

2. Predictable Cash Flows

Fixed interest rates are established at issuance, typically paying interest semiannually. Ideal for investors planning retirement funds.

3. Excellent Liquidity

As the most actively traded bond product, Treasuries can be sold at any time if needed. This flexibility is useful for portfolio adjustments or urgent cash needs.

4. Tax Benefits

Interest income from Treasuries is subject to federal income tax but exempt from state and local taxes, resulting in higher net returns.

Four Points to Watch Out for When Investing in U.S. Treasuries

1. Risk of Rising Interest Rates

When interest rates rise, newly issued Treasuries offer higher yields, reducing the relative value of existing bonds. Selling before maturity may incur losses.

2. Reduced Real Returns Due to Inflation

Fixed-rate Treasuries may not keep pace with inflation. If inflation exceeds Treasury yields, real purchasing power declines. TIPS(Treasury Inflation-Protected Securities) can be considered.

3. Currency Exchange Risk

For Korean investors, a weakening Korean won against the dollar can reduce interest income and principal value when converted back to KRW.

4. Political and Economic Credit Risks

Although extremely low, there is a theoretical possibility of U.S. government default. However, the high credit rating of the U.S. minimizes this risk.

Three Methods of Investing in U.S. Treasuries Compared

Direct Purchase

Individuals can buy and sell Treasuries directly via the U.S. Department of the Treasury’s TreasuryDirect website. There are no management fees, and interest is paid regularly until maturity. However, the purchase limit per transaction is $10,000, and significant capital and management effort are required for diversification. Suitable for conservative investors planning long-term holding and preferring direct management.

Indirect Investment via Bond Funds

Pooling funds from multiple investors to invest in diversified bond portfolios. Managed actively by professional fund managers, allowing response to market changes and diversification with smaller capital. Management fees apply, which may lower overall returns, and investors have no direct control over individual bonds. Recommended for those seeking professional management and diversification.

Index Tracking ETFs

Exchange-traded funds that track bond indices, offering low-cost passive management. They can be bought and sold freely on stock exchanges, providing high liquidity and transparency. Market volatility can affect ETF prices, despite the underlying bonds’ stability. Suitable for investors who prefer low-cost, index-based investment strategies.

Investment Strategies for Korean Investors in U.S. Treasuries

Currency Hedging Strategies

For Korean investors, USD exchange rate fluctuations are a key consideration. Using derivatives like forward contracts to lock in exchange rates can reduce currency risk. Partial hedging may be advantageous, as full hedging can limit gains during favorable exchange rate movements.

Duration Matching

(Duration) measures a bond’s sensitivity to interest rate changes. For principal preservation, longer-maturity U.S. Treasuries offer stability. To reduce interest rate volatility, a mix of shorter-maturity bonds can be employed.

Tax Optimization

Interest income from U.S. Treasuries is subject to U.S. federal tax but can benefit from double taxation treaties(DTA) between Korea and the U.S. for tax credits. Consulting tax professionals is recommended to develop optimal tax strategies.

Example Portfolio Composition: Korea and U.S. Treasuries

Consider a balanced portfolio with 50% Korean Treasuries and 50% U.S. Treasuries. This diversification reduces country-specific economic risks and naturally hedges currency risk by holding both KRW and USD.

A strategy of hedging 50% of U.S. Treasury exposure while leaving the other half unhedged can be effective. During periods of USD strength, higher yields from U.S. Treasuries provide gains; during USD weakness, the hedged portion offsets potential currency losses.

Conclusion

U.S. Treasuries are highly safe and predictable investment assets. However, understanding and managing risks related to interest rates, inflation, and exchange rates is crucial. By combining U.S. and Korean bonds, Korean investors can enhance both portfolio stability and returns. Choosing among direct purchase, bond funds, or ETFs should align with individual investment goals and risk tolerance.