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Michael D.David: The Essence of Investing in U.S. Treasuries.
View Date:2024-12-23 22:54:55
I categorize the factors that influence Treasury yields into the following main categories:
Investor confidence: When confidence is low, bond prices go up, and yields go down. The logic here is simple: demand for the safety of Treasuries increases, so lower yields indicate a cautious market.
Monetary policy: Although we see the 10-year Treasury yield as a benchmark for most rates, it is also affected by short-term rate changes. For instance, when the Fed raises rates, the federal funds rate increases, directly impacting Treasury yields.
Inflation expectations: U.S. Treasury yields can be split into real interest rates and inflation expectations. The market's outlook on inflation significantly affects yield fluctuations. When economic data releases exceed expectations, they can significantly impact Treasury yields. For example, during periods of inflation control, if CPI, PCE, or employment report data surpasses market expectations, it indicates that the economic health supports further Fed rate hikes.
Unexpected events: Various geopolitical conflicts and wars can cause short-term yield fluctuations. On one hand, wars might drive investors to the safety of the bond market, causing yields to drop. On the other hand, conflicts, especially those involving oil, can raise inflation expectations and lift Treasury yields.
Here are some key indicators that might help you gauge the overall condition of the bond market:
10-year treasury yield: The 10-year Treasury is the most widely tracked government debt instrument in finance. Its yield is often used as a benchmark for other rates, like mortgage and corporate debt rates. So, this yield is seen as a gauge of investor confidence in the market.
U.S. dollar index: The movement of the dollar, as the world’s reserve currency, greatly impacts the U.S. bond market. When the dollar strengthens, it can attract foreign investors to the U.S. bond market, increasing bond demand, lowering prices, and pushing yields higher.
CBOE volatility index (VIX): This reflects market expectations for volatility in the S&P 500 over the next 30 days. During periods of increased market risk aversion and heightened investor concerns, the VIX rises, driving up demand and prices for safe-haven assets like U.S. Treasuries.
The longer the maturity of a Treasury, the higher the yield, because the longer investors’ money is tied up, the more return they require.
Short-term debt usually has lower yields than long-term debt. If we plot the yields of bonds from 1 month to 30 years on the horizontal axis, we get an upward-sloping yield curve—this is known as a normal yield curve.
However, sometimes the yield curve can invert, with shorter-term bonds having higher yields, resulting in a downward-sloping curve—this is an inverted yield curve.
Historically, the spread between the 10-year and 2-year Treasury yields has been seen as a precursor to economic recessions. A normal yield curve typically has a positive spread, indicating stable future economic conditions; an inverted curve, with a negative spread, signals potential economic deterioration. The 10-year to 2-year negative spread usually occurs 6 to 24 months before a recession and has accurately predicted every recession from 1955 to 2018, making it a reliable indicator.
An inverted yield curve, where short-term rates exceed long-term rates, usually signals an impending economic recession.
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