Understanding Treasury Yields and Interest Rates: Key Insights for Bond Investors

Charlene Rhinehart, CPA, CFE, and chair of an Illinois CPA Society committee, holds degrees in accounting and finance from DePaul University.

Bond investors closely monitor Treasury yields and interest rates to anticipate market trends and adjust their portfolios accordingly. Rising rates often lead investors to prefer shorter maturities or hold bonds to maturity despite potential price declines, aiming to secure coupon payments and principal value.

Key Points to Remember

• Bonds with higher risk than Treasury securities must offer greater yields to attract investors.
• The Treasury yield curve displays yields across various maturities, reflecting market expectations.
• This curve represents the cost of U.S. government borrowing and is influenced by supply and demand.
• Changes in fiscal policy, central bank actions, and economic conditions shift the yield curve.

What Are Treasury Yields?

U.S. Treasury securities serve as the benchmark for pricing domestic debt and influence consumer interest rates. Corporate, mortgage, and municipal bond yields typically move in tandem with Treasury yields, which are set by the U.S. government.

Riskier bonds must compensate investors with higher yields compared to Treasuries of the same maturity; for instance, 30-year mortgage rates generally exceed 30-year Treasury yields by one to two percentage points.

The Treasury yield curve illustrates yields for securities of differing maturities, offering insight into anticipated interest rate movements over time.

Example of the Treasury Yield Curve

The typical yield curve slopes upward, indicating higher yields for longer maturities, reflecting increased risk over time.

The curve represents nominal interest rates, which are impacted by inflation expectations; the real interest rate accounts for inflation's effect on returns.

The Federal Reserve directly influences short-term rates through the federal funds rate, while the broader curve is shaped by market supply and demand, primarily driven by institutional investors.

How Long-Term Rates Respond to Short-Term Rates

The Treasury yield curve can experience various shifts: parallel moves up or down, changes in slope (flattening or steepening), and alterations in curvature.

• Parallel shifts affect all maturities similarly.
• Slope changes reflect varying investor sentiment about near- and long-term rates.
• Curvature adjustments indicate market expectations for economic cycles.

Historical data shows that 10-year and 2-year Treasury yields generally move together, with the spread between them indicating the curve's steepness and economic outlook.

Typically, rising short-term rates narrow the spread, flattening the curve, while falling short-term rates widen it, steepening the curve.

Current 10-Year Treasury Yield: 4.51% (as of Feb. 11, 2025)

This reflects an increase from 4.17% on Feb. 9, 2024.

Factors Driving Supply and Demand

The Treasury yield curve results from the interplay of capital flows, reflecting the cost of U.S. government borrowing influenced by supply and demand dynamics.

Supply Influences

Central Bank Actions: The Federal Reserve’s quantitative easing (QE) and tightening policies impact Treasury supply and yields by altering market expectations.

Fiscal Policy: Government deficits increase Treasury issuance, potentially pushing yields higher to attract lenders.

Demand Influences

Federal Funds Rate: Changes in this benchmark rate affect yields across maturities, influencing investor demand.

Trade Deficits: Large U.S. trade deficits result in foreign accumulation of Treasuries, supporting demand.

Regulatory Requirements: Banks and institutional investors require high-quality liquid assets like Treasuries, sustaining demand.

Inflation Expectations: Anticipated inflation raises nominal yields as investors seek compensation for reduced purchasing power.

Interest Rates and Inflation Dynamics

Increases in the federal funds rate tend to flatten the yield curve, balancing higher real interest rates with lower inflation expectations.

Economic Fundamentals

A robust U.S. economy often shifts investor preference toward corporate debt, reducing Treasury demand and raising yields, while economic weakness prompts a flight to quality, lowering yields.

The Federal Reserve typically raises rates only if economic growth threatens to spark unwanted inflation.

What Influences Treasury Yields?

Interest rates, inflation, and economic growth collectively determine Treasury yields, which respond to changes in each factor.

Impact of Rising Treasury Yields

Higher yields indicate reduced demand for Treasuries as investors pursue greater returns elsewhere, signaling confidence in economic prospects.

Why Inflation Pushes Treasury Yields Higher

To offset diminished purchasing power from inflation, Treasury yields rise, causing bond prices to fall.

Conclusion

Long-term Treasury yields generally track short-term rates but with a narrowing spread during rising rate environments due to expectations of slower growth and inflation. Investors can mitigate interest rate risk by shortening bond durations within their portfolios.

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