By Vikas Arkalgud – 1 June 2021
The US 10-year treasury yield is one of the most important interest rates in the world. In this article, we will explore what the US 10-year treasury is and why its yield figure is important to the macro economy.
What is the US 10-year Treasury?
Treasuries are debt instruments issued by the government. They yield a certain amount to the holder of the security as interest on the borrowed amount. They are generally considered safe instruments because they have the ‘full backing’ of the US Government. This essentially means that the US government guarantees that the principal will be repaid to the holder of the treasury at maturity. This safety of investment is one of the main aspects that makes the US 10-year Treasury yield so important as it is often considered the ‘risk-free rate of return’. It is also considered one of the most liquid securities, further improving its status. In addition, longer-term treasuries tend to yield more to incentivise holding on to the instrument longer. The 10-year treasury note in one such longer-term treasury.
How the Yield Moves
The US 10-year treasury yield is inversely proportional to its price. The yield increases when there is an increase in supply of the treasury; that is, people are selling more of the instrument, leading to a lower price, hence a higher yield. This is closely linked to monetary policy. A reason why investors may want to sell treasuries is that the Federal Reserve (‘the Fed’) raises interest rates by selling Treasury Bills to banks (thereby decreasing the money supply), and putting downward pressure on the US 10-year Treasury yield as it would have become less attractive to investors in light of the rising interest rates. Conversely, a decrease in the yield occurs when there is an increase in demand for the treasury; that is, people are buying more of the instrument, leading to a higher price, hence a lower yield. Investors may want to purchase more treasuries because the Fed has lowered interest rates by purchasing Treasury Bills from banks (thereby increasing the money supply), and putting upward pressure on the US 10-year Treasury yield as it would have become more attractive to investors in light of the falling interest rates. It is also important to remember that unlike stocks, an increase in yield for the US 10-year treasury is not in itself a good or bad thing.
What can the Yield can tell us?
One of the main reasons for why the US 10-year treasury yield is so important is that its value is considered a consensus about what investors and traders think of future economic prospects. When investors are more confident about future economic prospects, they will tend to sell off their bond holdings and purchase riskier assets (e.g. stocks), thereby leading to an increase in supply of treasuries, hence a fall in price and an increase in yield. When investors and traders are more uncertain about future economic prospects, they will generally dedicate a larger portion of their holdings towards treasuries. The reason for this is that treasuries are generally considered safer, especially if they are from the US given that America is considered a safe haven for investments. This ‘safe haven’ sentiment associated with the US 10-year treasury is another reason for why its yield is given so much attention.
Earlier in the article, it was noted that long-term treasuries tend to yield more than short-term treasuries as the former incorporates a risk premium for holding on to the security for longer, where the future becomes more and more uncertain. However, there are times when shorter-term treasuries yield more than longer-term treasuries. For example, if the US 2-year treasury yielded more than the US 10-year treasury. In such a case, it would be said that the yield curve is ‘inverted’; that is, there is a higher demand for long-term treasuries, thereby leading to a rise in their price and a fall in their yield. This higher demand usually occurs because investors see the long-term treasury as a relatively safe investment compared to equities or short-term treasuries. This acts as a signal to the economy that investors believe a recession is imminent as the short-term is riskier (this can be deduced from the fact that the 2-year treasury yield is higher than the 10-year treasury yield).
What does the current Yield tell us?
At the time of writing, the US 10-year treasury yield is hovering around 1.62%, having steadily climbed since August 2020. However, over the past few weeks, it has dipped from approximately 1.73% to 1.62%. The overall increase in yield over the past 8 months can be attributed to greater investor confidence in a post-COVID economic recovery. This has led to a sell-off in US 10-year treasuries and a rotation towards equities to protect portfolios against upward inflationary pressure. The recent dip in the 10-year treasury yield is likely due to a recent inflation report revealing inflation to not be as bad as was feared by some investors, and a halt of the US Johnson & Johnson vaccine, thereby prompting investors to purchase more 10-year Treasuries as a safety net.