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Treasury Yields

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US Savings Bond certificates
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What Are Treasury Yields?:

Treasury yields are a common term used to describe the total amount of money you make on U.S. Treasury notes or bonds. They are sold by the U.S. Treasury Department to pay for the U.S. debt. The most important thing to realize is that yields go down when there is a lot of demand for the bonds, which are considered ultra-safe investments. That's why yields move in the opposite direction of bond values.

How Does It Work?:

Treasury yields are determined by supply and demand. The bonds are initially sold at auction by the Treasury Department, which sets a fixed face value and interest rate. If there is a lot of demand, the bond will go to the highest bidder at a price above the face value. This lowers the yield, because the government will only pay back the face value plus the stated interest rate.

If, on the other hand, there is not a lot of demand, then the bidders will pay less than the face value, which will increase the yield. That is why yields always move in the opposite direction of bond prices.

Yield prices change every day, because hardly anyone keeps them for the full term. Instead, they are resold on the open market. Therefore, if you hear that bond prices dropped, then you know there is not a lot of demand for the bonds, and that yields must increase to compensate for lower demand.

How They Affect the Economy:

As Treasury yields increase, so do the interest rates on consumer and business loans with similar lengths. Investors like the safety and fixed returns of bonds. Treasuries are the safest, since they are guaranteed by the U.S. government. Other bonds are riskier, so must return higher yields to attract investors. As yields rise, so do interest rates on other bonds and loans to remain competitive.

As investors bid up yields on Treasuries in the secondary market, it also mean that the government itself will be forced to pay a higher interest rate to attract buyers in future auctions. Over time, these higher rates can start to increase demand for Treasuries. That's how higher yields can increase the value of the dollar.

How They Affect You:

The most direct way that Treasury yields affect you is their impact on fixed-rate mortgages. As yields rise, banks and other lenders realize they can charge more interest for mortgages of similar duration. The 10-year yield affects 15-year mortgages, and the 30-year yield impacts 30-year mortgages. Higher interest rates makes housing less affordable, depressing the housing market because it means you have to buy a smaller, less expensive home. This can slow GDP growth..

Did you know you can use yields to predict the future? You can, if you know about the yield curve. Usually, the longer the time frame on aTreasury, the higher the yield. Investors require a higher return for keeping their money tied up for a longer period of time. The higher the yield for a 10-year note or 30-year bond, the more optimistic traders are about the economy. Then need a higher return to compensate for holding their money up for longer when times are good. This is a normal yield curve.

However, if the yields on long-term bonds are low compared to short-term notes, then investors are uncertain about the economy, and are willing to leave their money tied up just to keep it safe. When long-term yields drop below short-term yields, you have an inverted yield curve. That usually predicts a recession.

For example, here's the yield curve for September 5, 2013:

  • .02 for the 3-month bill,
  • .16 for the 1-year note,
  • 2.98 for the 10-year note, and
  • 3.88 for the 30-year bond.

This is a healthy, upward-sloping yield curve. It shows that investors want a much higher return for the 30-year bond than for the 3-month bill. Investors are optimistic about the economy, and so would rather not tie up their money for ten or 30 years. (Source: U.S. Treasury, Daily Treasury Yield Curve Rates.

Outlook

In 2013, yields rose 75% between May and August alone. Investors are getting out of Treasuries as the Federal Reserve announces it will begin tapering its Quantitative Easing policy. That means it will start to reduce its $85 billion a month purchases of Treasuries and mortgage-backed securities. The Fed's is cutting back as the global economy improves.

In August 2013, the yield on the benchmark 10-year note rose to 2.88%. This drove mortgage interest rates to 4.57% for a 30-year fixed-interest loan. This was just two months after the yield hit 2.6%, which was itself a point higher than the year before. For more, see Why Wall Street Carnage Means Mortgage Rates Will Rise.

Over the next year, rates will probably rise even further. Analysts at Citi forecast that the 10-year note yield will hit 3.1% by the middle of 2014. Wells Capital Management predicts it could happen by the end of 2013. However, these are still historically low rates. (Source: CNBC, Market Consensus: Get Ready for 3% Treasury Yields, June 19,2013)

In the medium-term, there are ongoing pressures that keep yields relatively low. Foreign investors, notably China, Japan and oil-producing countries, need dollars to keep their economies functioning. The best way to collect dollars is by buying Treasury products. The popularity of Treasuries have kept yields below 6% for the last five years.

In the long-term, several factors will make Treasury products less popular over the next 20 years.

  • The huge U.S. debt worries foreign investors, who wonder if the U.S. will repay them. It especially worries China, the largest foreign holder. China often threatens to purchase less Treasuries, even at higher interest rates. If this happens, it would indicate a loss of confidence in the strength of the U.S. economy. This would ultimately drive down the value of the dollar.
  • One way the U.S. can reduce its debt is by letting the value of the dollar decline. When foreign governments demand repayment of the face value of the bonds, it will be worth less in their own currency if the dollar's value is lower.
  • The factors that caused China, Japan and oil-producing countries to buy Treasury bonds are changing. As their economies become stronger, they are using their current account surpluses to invest in their own country's infrastructure. They aren't as reliant upon the safety of U.S. Treasuries, and are starting to diversify away.
  • Finally, part of the attraction of U.S. Treasuries is that they are denominated in dollars, which are in effect a single global currency. Most oil contracts must be denominated in dollars. Most global financial transactions are done in dollars. As other currencies, such as the euro, become more popular, less transactions will be done in the dollar, lessening its value, and that of U.S. Treasuries.

The Yield Hit 200-year Lows in 2012:

On June 1, 2012, the benchmark 10-year note yield hit an intra-day low of 1.442 percent, the lowest level since the early 1800s. This was caused by a flight to safety, as investors moved their money out of Europe and the stock market. (Source: Reuters, Weak jobs data knock U.S. yields lower, June 1, 2012)

Yields were abnormally low due to continued economic uncertainty. Investors accepted these low returns just to keep their money safe. They were concerned about the eurozone debt crisis, the fiscal cliff, and the outcome of the 2012 Presidential election. (Source: U.S. Treasury Department, Daily Treasury Yield Curve Rate)

Treasury Yields Predicted The 2008 Financial Crisis:

In January 2006, the yield curve started to flatten. This meant that investors did not require a higher yield for longer term notes. On January 3, 2006 the yield on the 1-year note was 4.38%, a bit higher than the yield of 4.37% on the 10-year note. This was the dreaded inverted yield curve. It predicted the 2008 recession. In April 2000, an inverted yield curve also predicted the 2001 recession. When investors believe the economy is slumping, they would rather keep the longer 10-year note than buy and sell the shorter 1-year note, which may do worse next year when the note is due.

Most people ignored the inverted yield curve because the yields on the long-term notes were still low -- less than 5%. This meant that mortgage interest rates were still historically low, indicating plenty of liquidity in the economy to finance housing, investment and new businesses. Short-term rates were higher, thanks to Federal Reserve rate hikes. This mostly impacts adjustable rate mortgages. Long-term Treasury note yields stayed at around 4.5%, keeping fixed-rate mortgage interest rates stable at around 6.5%. (Updated August 20, 2013)

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