A Swiss reader asks about buying U.S. Treasury zero coupon bonds

Dear Chris,
I am planning to buy some US zero [coupon] bond treasuries on the OTC market here in Switzerland. I am not so sure which maturity I should choose. Should I choose longer dated or shorter dated treasuries?

In Christo,
F, Switzerland

Here was my response (edited for grammar);

Hi Franz,
I think zeros are a good way to go to with less money up front [since longer-dated zeros are sold at sizable discounts to face value principal and reinvestment risk is not an issue]. I don’t know about tax treatment for zeros where you live, but most here in the U.S. own them in deferred accounts like retirement plans, since the accretion income is considered taxable though nothing is actually received during the tax period.

My one concern here, and this is only short term, is that bond yields have fallen really fast. We may see some sort of retracement bounce in yields (drop in prices), but the trend is clearly intact. I see a world where the government will be the main driver that will keep things moving along and massive deficit spending will work to keep the economies afloat.

I get a skewed perspective living inside the U.S. as things are doing okay here. Europe and the former commonwealth nations are really struggling and I see no way out of this trend. This is why the euro and commonwealth currencies are struggling against the dollar.

Commodity-based currencies are responding to the dynamic we discussed in the past about commodities. Namely, these global monetary policies have created massive deflationary forces around the world as the sovereign debt pile balloons. Commodity prices struggle, and as the size of the debt rises, the deflationary forces overwhelm as debt servicing burdens rise higher.

Thus, as time goes on, the nation-state governments continue to crowd out and increase their influence over the global economy. Through central bank action, the governments spend more and more over time and their deficits escalate. They can continue to spend at lower yields, because the central banks basically are allowing them.

My concern here is that we could see negative rates over the next several years that could be mind blowing to many. I see no indication that this scheme will stop and it is clear [given last year’s U.S. Fed about-face] that the central banks have chosen this route to keep all debt in force and the national governments on the hook for all of it.

The only way forward; continually lower rates over time. There is no other answer.

So, if you are confident in the CHF maintaining its value vis-a-vis the USD (as it has been since the early 2015 CHF massacre), I would buy some zeros unhedged [or a partial hedge depending on your circumstances]. Although we may see some yield spikes in the short-term, I believe that would just provide an opportunity to increase investment holdings. The yield differentials are still extraordinary.

If I were your broker, I would try to ladder the duration of your holdings. If rates rise, perhaps lengthen the duration of additional purchases. Start out with shorter-term duration and build on that. It would be like buying on dips.

BTW, I came across a zero coupon bond calculator that can help out with how much some zeros may cost. You can also see how the bond price responds to changes in yield. Just plug in the yield changes and take the differences to get a rough estimate of potential gains and losses in USD.

Regards,
Chris