This week, investors considered their outlook for interest rates as the 10-year Treasury yield hit 4% for the first time since 2007.
The 10-year Treasury yield is one of the world’s most influential rates, affecting everything from mortgage rates to car loans. So, what factors influence its behaviour?
The U.S. economy
The 10-year Treasury yield is the interest rate investors are willing to pay the US government in return for lending them money for 10 years. The Treasury sells its bonds through auction and sets its yield via bidding processes; yield is often set through bidding as well. Investors generally view 10-year bonds as being safe investments due to their government’s high credit rating and less likely risk of default on its debts.
Economic growth and inflation both play a role in determining the 10-year Treasury yield, with strong economies typically driving yields higher as investors gain confidence in its future; on the other hand, rapid increases in consumer spending or inflation could unsettle investors and cause yields to drop precipitously.
Federal Reserve’s monetary policy also has an influence on 10-year Treasury yield. If they raise rates aggressively, investors may seek refuge in Treasury bonds; thus driving prices higher and yields down.
The Federal Reserve
The Federal Reserve is an influential central bank that plays an influential role in shaping interest rates and the economy through setting key policies. Its seven members, known as governors, are nominated by the president and confirmed by both chambers of Congress; its sole purpose being promoting full employment while maintaining stable prices.
The Federal Reserve can use various tools to control short-term interest rates, such as raising and lowering its federal funds target rate, to manage short-term rates. Furthermore, quantitative easing – an unconventional program in which Treasury bonds and mortgage-backed securities are purchased to lower longer-term interest rates – may also be deployed as a measure.
Investors closely track the Federal Reserve’s monetary policies to understand their effect on interest rates. Investors can follow its actions through press conferences and documents like its four-time-yearly summary of economic projections document. Investors may also purchase Treasury Inflation Protected Securities (TIPS). TIPS provide nominal returns that are adjusted for inflationary impacts.
International markets
The 10-year Treasury yield is a pivotal part of financial markets as a benchmark rate that impacts other borrowing rates – such as mortgages. Furthermore, this security is widely traded, meaning market fluctuations can have wide-reaching ramifications for global economies.
Investors seeking refuge from an uncertain economy often look toward Treasurys for safety; their protection comes from being backed by the full faith and credit of the US government. When these bonds become popular investments again, their prices often increase quickly; this drives down yields as prices and yields are often related.
An increasing 10-year Treasury yield directly affects anyone borrowing money to buy a home, invest in stocks or start their own company. Loan costs become more costly, slowing economic activity and possibly leading to job losses at some companies. But more broadly speaking it raises U.S. import costs further exerting pressure on international trading partners.
The bond market
The bond market is an international marketplace for companies, governments and individuals to borrow money by selling securities (i.e. loans) on primary and secondary markets. One of the more closely followed interest rates is 10-year Treasury yield; its direction can be affected by many factors including Fed action as well as investor trust.
The bond market offers investors a diverse array of investment options, from government-backed bonds and corporate securities, to individual investments such as buy/sell bonds on secondary market, mutual funds and ETFs that specialize in bonds or dedicated resources such as Investopedia’s Bond Market Overview or Morningstar’s Bond Center to help make more informed investment decisions. However, volatility remained high throughout 2023; investing should only be undertaken with caution and an understanding of this complex environment.