The Wild BIL
Investing in Bonds via ETF’s
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Volatility in bond and equity markets is set to continue if interest rates continue to rise, which is entirely dependent on what inflation does. While signs of cooling are positive, there are still issues with sticky inflation in wages and rent.
One positive of all this is that stable ETF’s, such as funds like BIL and SGOV, benefit from higher rates — these funds are affordable for most to invest in, at least a little.
The asset class performs best when real rates are positive and the opportunity cost of alternative investments is low. The current macro environment is challenging from an investment and monetary policy standpoint, but those challenges are driving opportunity costs lower, while real rates have a chance to be positive, while the Fed deals with stubborn inflation.
There will be great opportunities to invest in risk assets when rates have finished climbing, which will likely be soon.
What’s the deal
Continued monetary tightening is causing significant volatility in markets. The dramatic increase in short end rates is presenting both a challenge and opportunity. On one hand, higher risk-free rates result in higher discount rates that negatively impact risk asset valuations and cause the price of shares and bonds to decline. On the other hand, higher risk-free rates offer an attractive place to put cash to work.
Typically, T-bills reauire that two conditions need to be satisfied to justify the risk-adjusted returns of Treasury Bills, and usually one or both of these conditions are not satisfied:
- Real yields are positive
- Opportunity cost is low
In some circumstances the latter condition can outweigh the former, and hat was certainly the case for the first half of 2022.
For the next quarter, it appears that both conditions will be met.
Additionally, these funds pay healthy dividends and do not experience a lot of volatility, thus lower risk — this is hard to find during periods of strong inflation.
Two Reasons Inflation Will Persist
Generally, increases to wages lead to further inflation in consumer prices which further pressures wages higher, and so The Fed must reduce prices of consumer goods and services to prevent wages from rising. This is very difficult since rents are not dropping, and so lower wages will be tricky, thus costs to produce goods will remain high as well.
Bottom line
People who still have cash in their accounts and want to protect it may consider BIL or SGOV as viable shorter term options that offer guaranteed returns and low risk.
You won’t get rich this way, but you won’t lose either.
