Photo by Vladimir Solomianyi on Unsplash

Are Treasury Bonds Overvalued?

Checking the math

I saw a post on my LinkedIn asking why anyone would want to own bonds at current yields (10 year Treasuries currently yield around 4.6%). Unfortunately, I didn’t save it and now can’t find it for the life of me (LinkedIn’s search functionality is not so great). But the gist of it went:

1. Bonds don’t offer enough compensation for the risk.
2. If you bet on bonds, you’re implicitly betting that inflation will return to the Fed’s target (2% year over year) relatively soon.
3. This is a foolish bet.

Let’s check the math. Treasury bonds, while often called risk-free, actually do expose you to some risks — namely duration risk and inflation risk. Duration risk is the risk that interest rates change significantly from current levels. If rates go down, your 4.6% yielding bond suddenly looks pretty sweet versus the lower yields. If rates go up, your bond suddenly looks a lot worse. So at least in the short to medium term, the value of a bond can fluctuate significantly due to changes in interest rates.

The other risk is inflation risk. Bonds pay you a fixed return based on the market yield at the time you bought the bond. If you hold the bond to maturity (for Treasury bonds, you don’t need to worry about the U.S. defaulting), you are guaranteed to earn…