Bonds have regained their appeal as an income-generating asset after several years of interest rate rises. A US Treasury bond yielding just 0.22% at the start of 2022 now offers well above 4%, a meaningful shift for fixed-income investors.
While US residents can buy Treasuries directly through TreasuryDirect, the route is less straightforward for Canadian investors. The good news is that it remains entirely possible to invest in US Treasury bonds from Canada, through the secondary market or through ETFs.
In this article, we provide a step-by-step guide on how Canadian investors can invest in US Treasury bonds, including T-bills and T-notes. We also cover the currency and tax considerations that apply, which matter more than most guides acknowledge.
What are US Treasury bonds?
US Treasury bonds are debt securities issued by the United States Department of the Treasury to finance government operations and public spending. Backed by the full faith and credit of the US government, they are widely regarded as among the safest investments available.
Treasuries carry a fixed interest rate with maturities ranging from a few weeks to thirty years. They are sold at auction and can be bought by individuals, corporations, and foreign governments. Interest is exempt from US state and local taxes, though this is of no relevance to Canadian investors, who are taxed under Canadian rules rather than US state law.
Treasury bonds vs Treasury notes vs Treasury bills
All three are issued by the US Treasury, differing principally in maturity:
- Treasury bills (T-bills): maturities of one year or less, sold at a discount to face value rather than paying periodic interest. Your return is the difference between purchase price and face value at maturity;
- Treasury notes (T-notes): maturities of 2 to 10 years, paying interest every six months;
- Treasury bonds (T-bonds): maturities of 20 to 30 years, also paying interest every six months.
One point worth understanding before choosing: longer maturities carry greater interest rate risk. If rates rise after you buy, the market value of a 30-year bond falls far more than that of a 6-month bill. Investors holding long-dated Treasuries through the 2022 rate-hiking cycle experienced double-digit losses despite holding what is often described as a risk-free asset. That risk disappears only if you hold to maturity.
How to buy US Treasury bonds from Canada
US citizens can invest directly through TreasuryDirect.gov. Canadian residents are not eligible to open an account there, so the practical options are buying on the secondary market or investing through bond ETFs.
Two considerations specific to Canadian investors before covering the mechanics:
- Currency risk: Treasuries are denominated in US dollars. Your actual return combines the bond yield with the CAD/USD movement over your holding period. A 4% yield can be entirely offset by a 5% move in the exchange rate, so consider whether you want that exposure or would prefer a CAD-hedged ETF, several of which are listed on the TSX;
- Tax treatment: interest from Treasuries is generally not subject to US withholding tax for non-resident investors under the portfolio interest exemption, provided a valid W-8BEN is on file. The income remains fully taxable in Canada as interest income, which is taxed at your marginal rate rather than at the more favourable capital gains rate.
A further point on account type. Holding US Treasuries in an RRSP is generally more efficient than in a TFSA for US-source income, since the Canada-US tax treaty recognises RRSPs as retirement accounts but does not extend the same treatment to TFSAs. This matters more for dividend-paying US equities than for Treasuries, but is worth raising with an adviser before deciding where to hold them.
Note that some brokers do not support these products, so we focus on Interactive Brokers below.
Option 1: buy US Treasury bonds on the secondary market
Interactive Brokers allows you to invest in T-bills and Treasury bonds on the secondary market. Treasury markets are highly liquid with tight spreads, and IBKR charges a commission of 0.002% of face value (minimum $5) per trade.
Interactive Brokers offers access to over 1 million bonds, spanning US government securities, corporate bonds, and municipals. The Bond Scanner tool lets you filter by maturity, yield, and coupon, and compare pricing across venues.
Since bonds are classified as complex instruments, you will need to request bond trading permission within your IBKR account settings before placing a trade. This is straightforward but must be done in advance.
IBKR is also regulated in Canada by CIRO, with client assets covered by the Canadian Investor Protection Fund, and supports CAD as a base currency – relevant since you will be converting to USD to buy Treasuries.
Here is an example of a US Treasury listing on IBKR’s web platform:
Option 2: Buy US Treasury Bond ETFs
When selecting a Government Bond ETF, it’s crucial to evaluate both the risk and return it offers. Yield-to-Maturity represents the anticipated return on investment. Duration, on the other hand, indicates the level of risk you incur by investing in the Bond ETF.
If you are an Interactive Brokers user, you have the option to purchase a variety of bond ETFs. Interactive Brokers offers ETFs that track short-term and long-term bonds as well. As an example, which is in vogue due to inflation concerns, is the iShares 0-5 Year TIPS Bond Index ETF:
This ETF is a CAD-hedged US Treasury bond ETF to mitigate currency risk, so you are protected by currency movements between the USD and CAD.
You can also invest in unhedged ETFs if you are willing to invest in USD and accept the currency risk: beware that if your account balance is in CAD and you invest in USD, you’ll have to convert your money, and the broker will charge you a small currency conversion fee.
The pros and cons of Investing in US Treasury Bonds from Canada
Pros
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High Credit Quality: US Treasury Bonds are backed by the US government, which makes them highly creditworthy, and the possibility of default is minimal.
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Liquidity: Treasury Bonds can be easily bought and sold, with prices based on the coupon rate relative to current interest rates.
- Generally lower risk: Bonds are less risky than other products like stocks.
Cons
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Interest rate risk: As interest rates rise, the price of your bonds will fall.
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Inflation risk: the interest may not compensate for inflation.
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Currency risk: It is important to note that investing in USD bonds with non-hedged CAD-denominated funds exposes you to currency risk. This means that the fluctuation in exchange rates between USD and CAD could benefit or harm your investment. Holding USD-denominated assets exposes investors to currency risk (since their base currency is not the USD and needs to be converted).
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Historically lower returns: In the long run, bonds tend to perform worse than other riskier asset classes.
- A complex asset class: Bonds can be considered one of the most complex non-derivative assets. As mentioned before, their value is inversely proportional to interest rates - when rates increase, investors demand higher yields. However, the coupon and principal of bonds are fixed. That's why, in some brokers, you need to request trading permission to be able to trade those asset classes.
Conclusion
In conclusion, investing in US Treasury Bonds from Canada is a viable option for those looking for a stable investment opportunity. Using a platform like Interactive Brokers, investors can access the US Treasury market and purchase Treasury Bonds and T-Bills on the secondary market. Furthermore, purchasing a Government Bond ETF allows investors to diversify their portfolio by gaining exposure to various Treasury Bonds with varying durations.
It’s crucial to consider the risks involved, including currency risk and interest rate fluctuations. Evaluating the Yield-to-Maturity and Duration of a Government Bond ETF will assist you in determining the level of risk and potential returns associated with the investment.
Overall, investing in US Treasury Bonds can provide an excellent opportunity to diversify your portfolio, protect your capital, and achieve steady returns over time. With careful consideration of the risks involved and the variety of platforms available, investors from Canada can capitalize on this lucrative investment opportunity.
