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 Treasury yields go down when there is a lot of demand for Treasury products, which are considered ultra-safe investments. That's why Treasury yields move in the opposite direction of Treasury bond values.
How Do Treasury Yields Work?:
Treasury yields are determined by supply and demand. Treasuries 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 Treasury bond will go to the highest bidder at a price above the face value. This decreases 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 Treasury bond prices.
Treasury yields 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 Treasuries, and that yields must increase to compensate for lower demand.
How Treasury Yields Affect the Economy:
As Treasury yields increase, so do the
interest rates on
fixed-rate mortgages. This makes it more expensive to buy a home, so demand for homes decrease, and therefore so do the prices of homes. This, then, has a negative impact on the economy, and can slow
GDP growth.
Higher Treasury yields mean that the Treasury Department will be forced to pay a higher interest rate to attract buyers. Over time, these higher rates can start to increase demand for Treasury products. That's why higher Treasury yields can increase the
value of the dollar.
On the other hand, the huge U.S. debt worries investors, especially China, the largest foreign holder. China threatens to purchase less Treasuries, even at higher interest rates. As this happens, it indicates a loss of confidence in the strength of the U.S. economy. This drives down the value of the dollar.
How Treasury Yields Affect You:
The most direct way that Treasury yields affect you is in their
impact on fixed-rate mortgages. High demand for Treasury products means low yields, which means low interest rates. This makes housing more affordable, which stimulates the housing market and, hence, the economy.
Conversely, higher yields mean higher mortgage interest rates, which means you have to buy a smaller, less expensive home. This slows down the economy.
Recent Treasury Yield Trends:
Usually, the longer the time frame on a Treasury product, the higher the yield. Investors require a higher return for keeping their money tied up for a longer period of time. This is known as the
yield curve.
On June 1, 2012, the benchmark 10-year Treasury notes 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) On that day, the yield curve was:
- .07 for the 3-month Treasury bill,
- .17 for the 1-year Treasury note,
- 1.47 for the 10-year Treasury note, and
- 2.53 for the 30-year Treasury bond.
Yields are abnormally low due to continued economic uncertainty. Investors accept these low returns just to keep their money safe. Once the global recovery is in full swing again, Treasury yields should increase. (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 is known as an
inverted yield curve. It predicted the current
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%.
Treasury Yield Outlook:
Treasury yields may even drop lower until the November 2012 Presidential election. That's because uncertainty about the
eurozone debt crisis, the
fiscal cliff, and the future political direction of the U.S. economy will keep investors searching for the ultimate safe haven.
There are ongoing pressures keeping Treasury yields low, as well. 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.
Long term, however,several factors will make Treasury products less popular over the next 20 years.
- The U.S. debt and current account deficit. Foreign investors wonder if the U.S. will repay them.
- 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 Treasury bond, 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.
(Updated June 3, 2012)
