Why 3-Month T-Bill Is an Attractive Deal

The highest-yielding U.S. Treasury security you can buy today also is the least risky: the three-month Treasury bill.

In fact, the three-month T-bill’s current annualized yield, at 6.38%, is the highest in nearly 10 years. It’s up from 6.17% in mid-October.

The current yield is well above the 5.86% annualized yield on the longest-term Treasury security, the 30-year bond.

In a normal market, investors are paid more to lock up their money for longer periods. Why not today?

Two factors have created this odd divergence in Treasury yields:

* Belief that the economy is slowing--and therefore that inflation won’t resurge significantly--has given some investors more confidence to lock up their money in longer-term Treasury bonds.

To put it another way, shorter-term interest rates in general are being held up because the Federal Reserve is holding its key short-term rate at 6.5%. But investors who figure the Fed’s rate has peaked--and that the next move, eventually, will be down--are more inclined to lock in longer-term yields.

* The Treasury’s shift toward borrowing more via short-term bills, as it retires longer-term bonds with the budget surplus, has created a bigger supply of T-bills relative to demand.

That is forcing the government to pay more to attract buyers to those bills.

The Treasury is borrowing about $21 billion each week in three- and six-month T-bills. That is up from about $16 billion a week in June.

“It’s just a backup in supply,” said Randy Merk, bond portfolio manager at American Century Funds in Mountain View, Calif. In any case, he said he finds the 6.38% yield on three-month T-bills quite attractive relative to other short-term investment options.

Indeed, that yield beats the 6.20% seven-day compound yield on the average taxable money market mutual fund, according to yield-tracker Imoneynet.com.

Another advantage of Treasury bills over other options: Interest on Treasury securities is subject to federal income tax, but not to state income tax. That makes a meaningful difference in a high-tax state such as California.