Operation Twist, US Treasury Bonds = Very Very Expensive

This week the top story was that the Federal Reserve launched a new program named Operation Twist. To put this in my best southern accent, would y'all go borrow some money for something expensive like a house. What this does is make the interest rates for US Treasury Bonds very low, in fact to a record low. You should take advantage of this and investigate re-financing of your home if you have a mortgage. The first paragraph is from Vanguard. The last section is titled 56 years ago and shows how important it is for an investment to grow faster than the rate of inflation.

The topic of the last blog was that gold was expensive and should be avoided. Last week, the price of gold dropped by about 10% and ended the week at $1,637.50. This is not a buying opportunity and gold should be avoided. The reason for this drop included a significant cost increase to purchase and maintain a contract on gold.

The stock market is getting way too much help from the US Federal Government. You would think that the US stock market indexes would have gone up with this news from the Federal Reserve. Unfortunately, investors got stressed about why would the action be taken. Last week, the US stock market indexes went down the most since 2008. The week before, the US stock market indexes went up the most since 2009. It means that the US stock market is currently being driven by political forces rather than economic forces. Eventually, economic forces will reign supreme and political forces will go into the background.

Vanguard:

The economic data released this week were mixed, but long-term persistent troubles were enough for the Federal Open Market Committee (FOMC) to take additional steps in its efforts to boost the economy. On the housing front, existing-home sales increased, while new residential construction fell. The index of leading economic indicators grew, but at a slower pace. For the week ended September 23, the S&P 500 Index fell 6.5% to 1,136 (for a year-to-date total return—including price change plus dividends—of about -8.3%). The yield on the 10-year U.S. Treasury note fell 24 basis points to 1.84% (for a year-to-date decrease of 146 basis points).

Operation Twist, US Treasury Bonds = Very Very Expensive:

Last week the 10 year US Treasury Bond briefly reached a historically low level of 1.67%. This means that interest rates are lower now than the Great Recession, World War II, Korean War, Vietnam War, etc... The only reason it went this low was through the help of the Federal Reserve and is not sustainable.

What the Federal Reserve did was to tell investors to sell other stuff and buy US Treasury Bonds. Forget about all of the long term stuff like having an interest rate less than the rate of inflation, just focus on the short term that interest rates could go even lower.

So why are US Treasury Bonds more expensive as interest rates drop? The best way to illustrate this is to look at a 10 year bond at the interest rates of 3.5%, 7%, and 14%. Remember that US Treasury bonds have a known value at maturity and the cost to purchase it fluctuates with interest rates. For example, the ball-park cost to purchase a $1,000 10 year US Treasury bond with a 3.5% interest rate would be about $750, 7% interest rate would be about $500, while a 14% interest rate would be about $250. The lower the interest rate the higher the cost.

The reason for the statement that US Treasury Bonds are expensive is because the cost to buy these bonds is unusually high. As interest rates go up to more normal levels the value will go down and if you sell it before the maturity you will lose money. If you hold it and the inflation rate is higher you will lose. Yes you can lose money on US Treasury Bonds.

56 years ago:

The following comments were made in the year 1955! That’s only 56 years ago. Imagine what things are going to be like 56 years from now in 2067!

• “If cigarettes keep going up in price, I’m going to quit - 20 cents a pack is ridiculous.”
• “Drive-in restaurants are convenient in nice weather, but I seriously doubt they will ever catch on.”
• “Did you hear the post office is going to charge 7 cents just to mail a letter and also cancel the penny postcard?”
• “When I first started driving, who would have thought gasoline would someday cost 25 cents a gallon?”
• “I heard some scientists think it’s possible to put a man on the moon by the end of the century - ridiculous.”
• “Did you see where some baseball player signed a con-tract for $50,000 a year just to play ball?”
• “I never thought I’d see the day all our kitchen ap-pliances would be electric. They are even making electric typewriters now.”
• “I’m afraid the Volkswagen car is going to open the door to a whole lot of foreign business.”
• “There’s no sense going on short weekend trips any-more. It costs nearly $2.00 a night to stay in a hotel.”
• “No one can afford to be sick anymore. At $15.00 a day in the hospital, it’s too rich for my blood.”
• “30 cents for a hair cut, forget it.”