Auctioned every week, the Treasury bills (T-bills) are short-term debt obligations issued by the U.S. government. T-bills are issued through a competitive bidding process at a discount or at par (face value). Based on the investor’s demand for the bill, interest rates are determined at the auction.
Auction highlights for a six-month Treasury bill
Despite an increase in the six-month Treasury interest rates, last week’s coverage at 4.46x was lower than the previous week’s 4.76x bid/cover ratio. Often the six-month T-bill rate moves in tandem with the Federal funds rate target. When bondholders expect interest rates to rise, the six-month T-bill rate goes higher than the Fed funds rate; but when investors expect rates to decline, the six-month T-bill rate goes below the Fed funds rate target.
The U.S. Treasury Department issued $25 billion worth six-month T- bills on Monday, March 3, 2014, at 0.08% discount rate. The discount rate was slightly up from the previous week’s 0.07% discount rate.
What does the situation imply?
The bid-ask price in the T-bills is quoted very differently than in the Treasury notes and bonds since T-bills do not pay interest. The Treasury notes and bonds are generally mid-term to long-term Treasuries ranging from two years to 30 years. Bid price is the interest rate that the buyer proposes on the bill, whereas the ask price is the interest rate a seller (in this case, the U.S. Department of Treasury or the Federal Reserve) quotes on the bill. Since, the T-bills are issued for a shorter duration; the interest earned is the difference between purchase price and the face value of the bill, if held until maturity.
Investors (buyer of the bill) always quote a higher bid price on T-bills. A higher bid price means investors will receive a higher interest (difference between the face value and the price paid at the auction) at the time of maturity. However, issuers always like to quote low ask price, so that at the time of maturity they have to pay less interest to the investors.
Other things being equal, high bid/ask or bid/cover ratio implies that demand for the bill has increased. The demand increases with the rise in the interest rates, but decreases the bond prices. Interest rates and bond price are inversely correlated. If the interest rate goes up, then the bond prices fall and vice-versa.
For investors who wish to tap the short-term government bond market, relevant ETFs will include iShares Short Treasury Bond (SHV) and iShares 1-3 Year Treasury Bond (SHY). iShares Short Treasury Bond (SHV) tracks the performance of the Barclays U.S. Short Treasury Bond Index having maturity of between one and 12 months. iShares 1-3 Year Treasury Bond (SHY) seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Barclays U.S. 1-3 Year Treasury Bond Index. Prices on both ETFs declined last week as the U.S. six-month Treasury yield moved up by 10 basis point.
Investors may also diversify portfolio by considering a blend of short-term and long-term Treasury ETFs.
Ultra Sort Government T-bill ETF
The SPDR Barclays 1-3 Month T-Bill (BIL) is the ultra short government bond that includes all publicly issued zero-coupon U.S. Treasury Bills that have a remaining maturity of less than 3 months and more than 1 month. The ETF has a expense ratio of about 0.13%.
Other short-term ETFs
The S&P/Citi 1-3 Yr Intl Treasury Bond (ISHG) performance of treasury bonds issued in local currencies by developed market countries outside the U.S. with a remaining maturity between one and three years. The ETF has a expense ratio of about 0.35%.
Long-term government bond ETF
The iShares Barclays 20+ Year Treasury Bond (TLT) Fund seeks results that correspond generally to the price and yield performance, before fees and expenses, of the long-term sector of the United States Treasury market as defined by the Barclays Capital U.S. 20+ Year Treasury Bond Index. The ETF has a expense ratio of about 0.15%.