How do yields work on treasuries

We can make two observations here. Therefore, parallel shifts are common. Second, although long rates directionally follow short rates, they tend to lag in magnitude.

More specifically, when short rates rise, the spread between year and two-year yields tends to narrow curve of the spread flattens and when short rates fall, the spread widens curve becomes steeper. In particular, the increase in rates from to was accompanied by a flattening and inversion of the curve negative spread ; the drop in rates from to created a steeper curve in the spread, and; the marked drop in rates from to the end of produced an equally steep curve by historical standards.

So what moves the yield curve up or down? Well, let's admit we can't do justice to the complex dynamics of capital flows that interact to produce market interest rates. But we can keep in mind that the Treasury yield curve reflects the cost of U. Monetary Policy If the Fed wants to increase the fed funds rate, it supplies more short-term securities in open market operations.

The increase in the supply of short-term securities restricts the money in circulation since borrowers give money to the Fed.

In turn, this decrease in the money supply increases the short-term interest rate because there is less money in circulation credit available for borrowers. By increasing the supply of short-term securities, the Fed is yanking up the very left end of the curve, and the nearby short-term yields will snap quickly in lockstep.

Can we predict future short-term rates? Well, the expectations theory says that long-term rates embed a prediction of future short-term rates. But if we consider the actual yield curves observed in the markets over time, unfortunately, the pure form of this theory has not performed well: Interest rates often remain flat during a normal upward-sloping yield curve. Probably the best explanation for this is that, because a longer bond requires you to endure greater interest-rate uncertainty, there is extra yield contained in the two-year bond.

If we look at the yield curve from this point of view, the two-year yield contains two elements: a prediction of the future short-term rate plus extra yield i. So we could say that, while a steeply sloping yield curve portends an increase in the short-term rate, a gently upward-sloping curve, on the other hand, portends no change in the short-term rate—the upward slope is due only to the extra yield awarded for the uncertainty associated with longer- term bonds. Because Fed-watching is a professional sport, it is not enough to wait for an actual change in the fed funds rate, as only surprises count.

It is important for you, as a bond investor, to try to stay one step ahead of the rate, anticipating rather than observing its changes. Market participants around the globe carefully scrutinize the wording of each Fed announcement and the Fed governors' speeches in a vigorous attempt to discern future intentions. Fiscal Policy When the U. The more the government borrows, the more supply of debt it issues. At some point, as the borrowing increases, the U. However, foreign lenders will always be happy to hold bonds in the U.

Inflation If we assume that borrowers of U. The factors that create demand for Treasuries include economic growth , competitive currencies , and hedging opportunities. A stronger U. A weaker economy, on the other hand, promotes a "flight to quality," increasing the demand for Treasuries, which creates lower yields. It is sometimes assumed that a strong economy will automatically prompt the Fed to raise short-term rates, but not necessarily.

Only when growth translates or overheats into higher prices is the Fed likely to raise rates. In the global economy, Treasury bonds compete with other nations' debt.

On the global stage, Treasuries represent an investment in both the U. Finally, Treasuries play a huge role in the hedging activities of market participants. In environments of falling interest rates, many holders of mortgage-backed securities , for instance, have been hedging their prepayment risk by purchasing long-term Treasuries. We have covered some of the key traditional factors associated with interest rate movements.

On the supply side, monetary policy determines how much government debt and money are injected into the economy. On the demand side, inflation expectations are the key factor. However, we have also discussed other important influences on interest rates, including fiscal policy that is, how much does the government need to borrow?

Here is a summary chart of the different factors influencing interest rates:. Both the discount yield and the investment yield, as well as the high, low and average prices of the auctioned T-bills, are made public in an official Treasury report shortly after the auction. The Treasury uses the discount and investment formulas for calculating yields on all T-bills, except the one-year bill. Yields reported by the Treasury are precise to several decimal places.

The Investment Yield Method When comparing the return on investment in T-bills to other short-term investment options, the investment yield method can be used. This yield is alternatively called the bond equivalent yield, the coupon equivalent rate, the effective yield and the interest yield. The return on a Treasury note or bond is equal to its face value times the coupon interest rate. Formulas used by Treasury to calculate the investment yield on notes and bonds are complicated and vary, depending on the maturity of the issue.

By continuing to use our site, you agree to our Terms of Use and Privacy Statement. Did you know that you can use yields to predict the future? The longer the time frame on a Treasury, 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 year note or year bond, the more optimistic traders are about the economy. This is a normal yield curve. If the yields on long-term bonds are low compared to short-term notes, investors could be uncertain about the economy.

They may be willing to leave their money tied up just to keep it safe. It predicts a recession. One way to quantify this is with the Treasury yield spread. For example, the spread between the two-year note and the year note tells you how much more yield investors require to invest in the longer-term bond. The smaller the spread, the flatter the curve. The yield curve reached a post-recession peak on Jan. The two-year note yield was 0. That's 2. This is an upward-sloping yield curve.

It revealed that investors wanted a higher return for the year note than for the 2-year note. Investors were optimistic about the economy. They wanted to keep spare cash in short-term bills, instead of tying up their money for 10 years.

The yield curve then flattened. For example, the spread fell to 1. The yield on the two-year note was 0. Investors had become less optimistic about long-term growth. They didn't require as much of a yield to tie up their money for longer. On Dec. The yield on the five-year note was 2. That's slightly lower than the yield of 2. In this case, you want to look at the spread between the three-year and five-year notes.

It was On March 22, , the Treasury yield curve inverted more. The yield on the year note fell to 2. That's 0. The Federal Reserve Bank of Cleveland has found the yield curve is often used to predict recessions. It reliably predicted a recession would occur about a year out. In fact, there were two times the curve inverted and a recession didn't occur at all.

On August 12, , the year yield hit a three-year low of 1. That was below the one-year note yield of 1. On August 14, the year yield briefly fell below that of the two-year note. Although the dollar was strengthening, it was due to a flight to safety as investors rushed to Treasurys. The inversion began on Feb. The yield on the year note fell to 1.

The inversion steadily worsened as the situation grew worse. Investors flocked to Treasurys and yields fell, setting new record lows along the way.

By March 9, the year note had fallen to a record low of 0. The yield on the one-month bill was higher, at 0. The chart below illustrates yield curves starting in until March 9, It shows that inverted yield curves often predict a recession.

The Fed started raising the fed funds rate beginning in December , but lowered it again in and There are ongoing pressures to keep yields low. Economic uncertainty in the European Union, for example, can keep investors buying traditionally safe U. Foreign investors, China, Japan, and oil-producing countries, in particular, need U.

The best way to collect dollars is by purchasing Treasury products.