Callable Federal Farm Credit Bank Notes are Attractive

Here is a risky strategy that I am following as interest rates move lower.

As the section on agency bonds on aptly points out, Federal agency notes can provide excellent returns in low rate and declining rate environments such as the current one. I am posting this article here detailing how I have been using these instruments to improve my yield on cash equivalents effectively. I hope that this article can help some folks but I hope not to help too many as exposing this could dry up the market that I have been a beneficiary of if too many act.

Through my broker, I have recently found long-term agency bonds (2018 to 2025) trading around 5%.  Because of forced liquidations, I presume, these bonds are often trading around 99% of par.  I snap the discounted ones right up, even though they are callable.  If they are called, then I get a couple of weeks of 5% interest - state and local tax free - and I also make an additional 1% profit (on the move from 99% to being called at par).

There is a risk here and many feel that the risk is too great to tolerate.  The risk is that interest rates spike higher and I am left holding bonds that are trading at a significant discount.  If that happens, I could suffer significant losses (or hold a poor-yielding instrument to maturity).  But, my view is that interest rates are low, 2.7% on the 10-year, and going lower.  We are clearly not entering into a high rate environment, but we are facing disinflation.

These agency are now more clearly going to be backed by the government following the Fannie and Freddie bailouts. Therefore, I view this risk as no greater than the risk of buying equivalent duration US Treasuries.

I am finding the best deals on Federal Farm Credit Bank Notes these days, but I also invest in TVAs and Federal Home Loan Bank Notes as these three are all state and local tax free.

Jason Rodgers
Jason Rodgers: Jason Rodgers was an experienced research analyst for a major bank prior to retiring to run his own investment consultancy in beautiful Lihue, Hawaii. Jason contributed articles to BestCashCow from 2008 to 2014.

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