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US Treasury yields are often referred to as the risk-free rate, much to the frustration of certain finance professionals.
Yes, it’s true that you can lose money on them, as many investors have discovered since 2022. However, they continue to be the dominant reserve asset, and despite occasional Republican negativity, the creditworthiness of US government debt remains unquestionable. In a world of undesirable options, USTs are the least unfavorable.
In fact, Treasuries are even more advantageous than risk-free! Because US bills, notes, and bonds are highly liquid and widely used as collateral for various transactions, they are considered close to being equivalent to money (especially shorter-term bills).
This means that you can easily convert large amounts of Treasury holdings into cash whenever you want. In other words, they are practically money themselves. And this convenience is something that investors are willing to pay for. But how much?
Well, the New York Federal Reserve recently published an fascinating blog post exploring this topic. They have analyzed an implicit risk-free rate derived from S&P 500 index options (referred to as the “box rate”) and compared it to the yield of Treasuries.
Here’s the comparison:
And here is the historical comparison between the box rate and Treasury yields over time. As you can see, USTs have consistently traded at about 20-40 basis points below the implied risk-free rate.
Other studies have shown similar results around the world. However, the premium that investors are willing to pay for Treasuries is arguably the most significant, given the role of the dollar in global funding.
It also has direct and substantial benefits for the US. According to Jules van Binsbergen, William Diamond, and Peter Van Tassel at the NY Fed, it has saved US taxpayers approximately $35 billion in interest payments per year over the past two decades, and since 2020, it’s been around $70 billion annually.
That’s quite substantial, even in today’s world. It covers the entire US foreign aid budget and over half of the transportation budget.
This evidence strongly supports the continued strengthening of the Treasury market as a valuable investment.
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