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The Impact of the “N-Coupon” Bond

Evan Cooper Oct 06, 2015


And you thought things were already weird.

On Monday, the U.S. Treasury sold a new three-month government IOU at zero percent interest. Lenders, in effect, are saying, “Here Uncle Sam, take my dollar today and give it back to me three months from now, in exchange for which I expect nothing.”

Previous sales of one-month Treasury securities also have resulted in yields of zero, but this is the first time that a longer-term instrument also sold for “nothing.” What gives? Isn’t buying government debt for nothing the same thing as holding currency? Why would anyone want to buy the Seinfeld of securities — a note that yields nothing?


Economic Twilight Zone


In economics as in physics, when things approach absolute zero they get weird.

Institutional investors and traders snapped up what we can call the Treasury’s “N-coupon” securities largely because there’s nothing else they can do. They need Treasuries to fund their activities in the repo market, where the Himalayas of debt that prop up the global economy must be constantly refunded. Stop the flow of Treasury debt (even if it pays nothing) and the real-world economy could come to a screeching halt as the globe’s financial engine runs out of oil, overheats and locks up.

Since the U.S. is reaching its statutory debt limit, the Treasury has been careful in the amount of money it’s borrowing. So when you match the lower supply of Treasury debt with voracious demand you get higher prices — which in bond land means lower yields. And in the already low interest rate environment, that means no yield.


Now What?


It all makes sense technically, but what does no-interest interest mean for the average individual investor who looks to fixed-income investments for steady returns? Well, you could be a conspiracy nut and say it’s all part of a big-guy scheme to save themselves at the expense of the little guy. And you know what, there’s probably a large degree of truth in that analysis, despite sneers from Wall Street (which profits from zero times) and government officials (who sniff at anything that reeks of ordinary folk having the temerity to question the experts).

But I think most of the reason for the low and no cost of money is that there simply isn’t much demand for it. My belief is that we’re in a global depression that’s been papered over, so to speak, by all the government paper that’s been issued. In the 1930s, the U.S. threw money against the Depression through the New Deal, which was penny ante compared to the debt creation of late. Other nations (namely Germany, Italy and Japan) created debt by gearing up for war, which “worked” to create employment — until 1939. This time, no war yet, thank goodness, but lots and lots and debt.


Impact on Individual Investors


Whether intentional even in part, though, the low-interest rate world has made fixed-income investing extremely unrewarding for investors, prodding many of them into dividend-paying equities. That, of course, has made successful dividend investing even more challenging as demand for dividend-paying stocks has grown stronger.

While it isn’t as soul-stirring or hope-inspiring as a euphoric stock pitch by someone like Jim Cramer, let me offer some prudent suggestions for individuals seeking safety and some kind of return: first, lower your expectations. We’re in a low- or no-growth economic climate unlike the recent past; real corporate profitability and real interest rates will remain low for a while. Second, be skeptical about Wall Street’s seemingly sensible but inevitably expensive and usually ill-timed complex and potentially higher-returning investments. Third, diversify. And finally, choose solid dividend-paying stocks, but don’t pay excessive prices for them.


Image courtesy of David Castillo Dominici at FreeDigitalPhotos.net

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