Drastic times call for drastic measures
Photo by Ante Hamersmit on Unsplash
We are in “unprecedented” times; a “polycrisis.”
A pandemic, war in Ukraine, inflation, supply chain issues, an impending recession, high government debt, rising energy prices, climate issues, and political divide.
It may seem like we are facing many issues, but these have been ongoing for months. There’s almost nothing new to discuss.
One new topic to discuss is the rising short-term interest rates and falling financial markets.
Interest Rates
The Federal Reserve has been raising the benchmark interest rate for the last few months. Since raising rates in March, the Fed has raised rates at each of the following meetings. And they will raise rates at their September meeting (September 20–21); it is widely accepted the rate increase will be 0.75%.
Interest rates are now at an elevated level. After years of being held near zero, they are finally above the Fed’s inflation target of ~2%. The only issue,inflation is now at 8%.
So the 2% interest you receive on your savings is still losing purchasing power in comparison to the current inflation rate.
Similarly, the 3% interest from government treasuries also loses purchasing power. But at least it provides investors with a small return, compared to stocks, which have tanked for all of 2022.
Source
The black line represents the current interest rates from U.S. Treasury yields, the highest they have been in many years. Long-term and short-term treasuries are offering yields not seen in years.
Should You Buy Bonds?
There are, of course, many options when considering bonds. But for these purposes, we will only look at U.S. Treasuries.
While some of the longer-term treasuries can offer more than 3% for a decade(s), those are not what caught my attention. Not listed in the image above are the rates for 1-Month and 2-Month.
The 1-Month is above 2.50% and the 2-Month is at 3%.
These are tempting investments. As long as the next month’s inflation rate is below 2.50%, or inflation for the next two months is below 3%, these would be good investments.
And not to mention, there is no state income tax on treasury bill interest.
Opportunity Cost
Investing in short-term treasury bills makes sense when looking at the real interest rate. But there are other uses for your money than just treasury bills.
The two most relevant are stocks and cash.
YTD the stock market is down around 20%. A small gain of ~2–3% from treasuries is better than losing money.
However, the market is a long-term investment. Investing today, or even at the beginning of the year, into the stock market is a choice for the long haul. Over time, the stock market will go up.
As the market continues to slide down, the money put into treasury bills could instead be used toDollar Cost Averageinto the market.
The other option, cash, is a sensible alternative givenour uncertain future. Bloomberg Economics’ Model says there’s a 100% probability of a recession by the start of 2024. (Not sure if I’d describe them as optimistic or realistic. )
Currently, the unemployment rate is extremely low, which means it can only worsen.
Inflation is still persistent and energy prices are still high as winter approaches.
Cash can be an excellent option for unexpected turbulence in the next year. It is also a great option to hold and invest in the stock market if / when prices fall some more.
Final Thoughts
In addition to treasury bills, another investment to consider isI bonds. They currently yield ~8% but require a longer commitment (at least a year.)
Personally, I am not investing in any bonds — treasuries or I bonds. I’ve considered I bonds and may look more into short-term (1-Month or 2-Month treasuries). For now, I want to build cash.
I still believe in dollar cost averaging into the stock market.
I believe markets can continue falling into 2023. Thus, I’d like to have a sizable pile of cash available to dump into the market if things get bad. And if they don’t, then I will keep dollar cost averaging, per usual.
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