KEY TAKEAWAYS

• Treasury securities are loans to the federal government whose maturities range from weeks to as many as 30 years.
• Treasury securities are considered safer investments relative to stocks because they are backed by the U.S. government.
• Bond prices and yields move in opposite directions, which means that falling prices boost yields and rising prices lower yields.
• The 10-year yield is used as a proxy for mortgage rates and is also seen as a sign of investor sentiment about the economy.
• A rising yield indicates falling demand for Treasury bonds, which means investors prefer higher-risk, higher-reward investments, while falling yield suggests the opposite.

This bond [10-year Treasury] also tends to signal investor confidence. The U.S Treasury sells bonds via auction and yields are set through a bidding process. Prices for the 10-year bond drop when confidence is high, which causes yields to rise. This is because investors feel they can find higher-returning investments elsewhere and do not feel they need to play it safe.

… The geopolitical situations of other countries can affect U.S. government bond prices, as the U.S. is seen as safe haven for capital. This can push up prices of U.S. government bonds as demand increases, thus lowering yields.

Another factor related to the yield is the time to maturity. The longer the Treasury bond’s time to maturity, the higher the rates (or yields) because investors demand to get paid more the longer their money is tied up. Short-term debt typically pays lower yields than long-term debt, which is called a normal yield curve. At times, the yield curve can be inverted² with shorter maturities paying higher yields.

While rates do not have a wide dispersion, any change is considered highly significant. Large changes of 100 basis points (bps) can, over time, redefine the economic landscape.

Using the U.S. Treasury website³, investors can easily analyze historical 10-year Treasury bond yields.

The 10-year Treasury is an economic indicator. Its yield provides information about investor confidence. While historical yield ranges do not appear wide, any basis point movement is a signal to the market.

The 10-year Treasury yield serves as a benchmark for a wide range of interest rates including those for mortgages, corporate bonds, and other loans. When the yield on the 10-year Treasury rises, borrowing costs across the economy typically increase as well. This affects everything from consumer spending on big-ticket items like homes and cars to business investments in new projects and expansions. When the yield falls, it lowers borrowing costs which can stimulate the economy.

The yield on the 10-year Treasury is a key indicator of investor sentiment about the economy’s future health. A rising yield often suggests that investors expect stronger economic growth and higher inflation which prompts them to demand higher returns. A declining yield indicates that investors are seeking safety amid economic uncertainty which can be a sign of anticipated economic slowdown or deflation.

The 10-year Treasury yield plays a part in the valuation of financial assets. It is commonly used as a discount rate in models that value future earnings and cash flows. When the yield is low, it can boost stock prices because the present value of future earnings is higher. A higher yield can lead to lower stock valuations as the cost of capital increases, making equities less attractive compared to the risk-free return on government bonds.

The 10-year Treasury yield is closely watched by the Federal Reserve and other central banks as part of their assessment of economic conditions. It helps guide decisions on setting short-term interest rates and other monetary policy measures. A rising yield might prompt the Fed to raise short-term rates to prevent the economy from overheating, while a falling yield could lead to lower rates to support economic growth.

As a safe and highly liquid investment, the 10-year Treasury bond is a pretty big part of global financial markets. Its yield influences investment decisions worldwide, affecting capital flows between countries. For example, higher yields attract foreign investors seeking stable returns who might have otherwise kept their capital in their domestic country.

Monetary policy decisions by the Federal Reserve are another contributor to the 10-year Treasury yield. When the Fed raises short-term interest rates to curb inflation or cool down an overheating economy, yields on longer-term Treasuries like the 10-year bond often increase in response. This is because higher short-term rates can signal future rate hikes, leading investors to demand higher yields for longer-term investments. When the Fed lowers rates to stimulate economic growth, yields on longer-term Treasuries typically fall as lower short-term rates signal a more accommodative monetary policy stance.

Last, there’s always the risk that global economic conditions and geopolitical events also influence the 10-year Treasury yield. International economic slowdowns or crises in other countries can drive international investors to seek the relative safety of U.S. Treasuries. Additionally, geopolitical tensions or uncertainties such as trade wars or political instability can lead to flight-to-safety behavior among investors, making some flock towards safer securities and making others move away.

There are four different types of Treasury securities that are offered to investors by the U.S. government. Treasury Bills⁴ are loans to the federal government that mature at terms ranging from a few days to 52 weeks. A Treasury Note⁵ matures in two to 10 years, while a Treasury Bond⁶ matures in 20 or 30 years. Treasury Inflation-Protected Securities (TIPS)⁷ are assets whose principal balance changes based on fluctuations in the Consumer Price Index (CPI). They mature withing 5, 10, and 30 years.

An inverted yield curve shows that long-term U.S. Treasury debt interest rates are less than short-term interest rates. When the yield curve is inverted, yields decrease the farther out the maturity date is. Sometimes referred to as a negative yield curve, the inverted curve has proven to be a reliable indicator of a recession.

KEY TAKEAWAYS

• The yield curve graphically represents yields on similar debt securities across a variety of maturities.
• An inverted yield curve forms when short-term debt instruments have higher yields than long-term instruments of the same credit risk profile.
• An inverted yield curve is unusual; a normal yield curve slopes upward, displaying yields that run from low to high as maturities increase.
• The inverted curve reflects bond investors’ expectations for a decline in longer-term interest rates, a view typically associated with recessions.
• Market participants and economists use a variety of yield spreads as a proxy for the yield curve.

Analysts often distill yield curve signals to a spread between two maturities. This simplifies the task of interpreting a yield curve in which an inversion exists between some maturities but not others. The downside is that there is no general agreement as to which spread serves as the most reliable recession indicator.

… a yield curve inverts when long-term interest rates drop below short-term rates, indicating that investors are moving money away from short-term bonds and into long-term ones. This suggests that the market as a whole is becoming more pessimistic about the economic prospects for the near future.

Such an inversion has served as a relatively reliable recession indicator in the modern era. Because yield curve inversions are relatively rare yet have often preceded recessions, they typically draw heavy scrutiny from financial market participants.

Academic studies of the relationship between an inverted yield curve and recessions have tended to look at the spread between the yields on the 10-year U.S. Treasury bond and the three-month Treasury bill. On the other hand, market participants have more often focused on the yield spread between the 10-year and two-year bonds.

Federal Reserve Chair Jerome Powell said in March 2022 that he prefers to gauge recession risk by focusing on the difference between the current three-month Treasury bill rate and the market pricing of derivatives predicting the same rate 18 months later.

The 10-year to two-year Treasury spread has been a generally reliable recession indicator since providing a false positive in the mid-1960s. That hasn’t stopped a long list of senior U.S. economic officials from discounting its predictive powers over the years.

While an inverted yield curve has often preceded recessions in recent decades, it does not cause them. Rather, bond prices reflect investors’ expectations that longer-term yields will decline, as typically happens in a recession.