Are long-term U.S. government bonds risk-free?

Bonds / Fixed Income
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January 2017
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No.

In my opinion, there are three types of risk involved when dealing with bonds; credit risk, liquidity risk, and interest rate risk.

Are US Treasuries free of credit risk? Most likely, as a US investor, it is the best credit one can get, as if a US Treasury bond cannot make a required interest payment, or pay principal upon redemption, it would be catastrophic for the exchange value of the US dollar, and catastrophic for the US and global economy. Many other things would go horribly wrong in short order should the US default on its debts.

Are US Treasuries free of liquidity risk? Most likely, due to the US currency being a global reserve currency and sheer number of bonds traded during a normal day. Something would have to change with regard to credit (mentioned above), status as a reserve currency, or lack of US Treasury bonds on the market to create liquidity risk.

Are US Treasuries free of interest rate risk? No. As one goes further out in maturity to capture yield, the interest rate risk on any fixed rate bond increases. An investor buys a specific coupon rate for a period of time when they buy a fixed rate, fixed maturity bond. If longer-term interest rates increase, the current value of a longer-term bond decreases, and if longer-term interest rates decline, the current value of a longer-term bond increases. This relationship is based on the relative value of the interest rate the investor bought versus the interest rate that could be bought presently on similar maturity, similar quality bonds in the open market.

In my opinion, interest rate risk is where investors should focus their efforts when dealing with US Treasuries.

A fourth risk would be currency risk, but that would primarily apply to foreign investors, or US investors evaluating portfolio performance via some measure of comparative global purchasing power.

Steve

January 2017
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