Home Investing The Importance of the 10-Year Treasury for Investors

The Importance of the 10-Year Treasury for Investors

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The Importance of the 10-Year Treasury for Investors
photo / AlphaTradeZone/ Pexels

The 10-year Treasury yield plays a crucial role in the lending market, serving as a reliable indicator of potential changes in borrowing rates. It’s often compared to a weatherman, predicting shifts in interest rates on various financial products, including bonds and mortgages.

Photo / AlphaTradeZone/ Pexels

Due to its reputation as the safest long-term investment, the 10-year Treasury yield holds global significance as a widely referenced interest rate benchmark. Investment experts, like Jake Remley, highlight its importance in financial markets, even for those who don’t directly invest in bonds. Utilizing the 10-year Treasury yield, one can assess and value the future cash flows of their assets.

Understanding the impact of the 10-year Treasury yield on investments becomes crucial for investors across different financial instruments and portfolios. As this yield fluctuates, it can influence the overall borrowing costs and potentially affect the profitability of various investment ventures. Being aware of these dynamics helps investors make informed decisions and strategize their financial positions accordingly.

What is the 10-year Treasury yield?

The 10-year Treasury yield is an annualized rate of return applicable to a 10-year Treasury note issued by the U.S. government, intended to be held until maturity. Referred to as the ‘risk-free rate,’ this is due to the U.S. government’s reliable reputation in paying its debts and managing its finances. This rate is widely used in financial valuations and serves as a reference rate for various calculations.

Discounted cash flow calculations often utilize the 10-year Treasury yield to estimate the present value of an investment based on its future income. Additionally, it helps determine the interest rate premium, known as the spread, that investors may expect from other securities.

The significance of the 10-year Treasury yield extends beyond the U.S. markets; it acts as a baseline interest rate for various financial markets globally. Furthermore, it serves as a crucial economic indicator, providing insights into the business cycle and potential stages of economic growth or decline.

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What is the current 10-year Treasury yield?

As of early July, the 10-year Treasury yield stood at approximately 4%, slightly lower than the peak of about 4.25% observed in mid-October 2022. Throughout 2023, the average yield has been around 3.6%. This suggests that economic growth may continue to be subdued and could even enter negative territory, as the 10-year Treasury yield is currently lower than the two-year Treasury yield.

An important indicator to consider is the yield curve, which compares short-term and long-term interest rates. An inverted yield curve occurs when short-term rates are higher than long-term rates. This inversion has historically been associated with an impending recession.

Looking back at past data, we see that every recession since the 1970s has been preceded by an inverted yield curve. Usually, recessions occurred within a year of the inversion. However, there was a case in the 1960s where the yield curve inverted without being followed by a recession. While yield curve inversions typically precede recessions, they do not always guarantee an economic downturn. Factors like government policies and global economic conditions can also influence the outcomes.

Factors that affect the 10-year Treasury yield

The yield on 10-year Treasury notes is influenced by various factors, with inflation and investors’ perceptions of the economy being key drivers.

Macroeconomic indicators, like the Bureau of Labor Statistics’ consumer price index (CPI) and nonfarm payroll report, play a significant role in affecting the 10-year Treasury yield. When the CPI rises, indicating higher prices, investors may demand a higher yield on fixed-income securities to preserve their purchasing power.

Conversely, an increase in the national unemployment rate tends to lower the 10-year Treasury yield. In times of uncertainty, investors often turn to the safety of U.S. government-backed assets, driving up demand for Treasury securities and causing yields to decrease.

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Interestingly, market perception can also impact yields apart from actual economic changes. If investors anticipate an economic downturn, they may expect the Federal Open Market Committee to implement accommodative monetary policies by lowering future interest rates. As a result, they might purchase long-term bonds to lock in the current higher rates, leading to a subsequent fall in yields as bond prices rise.

When investors have confidence in the economy, the opposite occurs. They become less inclined to seek the safety of Treasuries, causing reduced demand and, in turn, a rise in yields.

10-year Treasury yield over time

Over the past year, the 10-year Treasury yield has been steadily increasing after hitting a low of 0.5% in 2020. This decrease in rates was a result of low inflation during that period, which changed when the market was impacted by COVID-19, leading to a rise in inflation. In February 2022, the yield finally surpassed 2%, which is considered the long-term rate of inflation, as the Consumer Price Index (CPI) rose by 7.9% compared to the previous year.

Looking at historical data, it’s interesting to note that yields of 3% to 4% may not seem very attractive now, but in the past, they were considered enticing. For instance, back in September 1981, when inflation surged to 11.8% annually, the 10-year Treasury yield reached an astonishing 15.84%. However, inflation subsided in the following year, causing the yield to drop to just above 10% in November 1982. Unfortunately, this decline was short-lived, as it spiked again to nearly 14% by May 1984.

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The subsequent year and a half saw a continuous decline in the 10-year Treasury yield. Financial experts attribute this drop to several factors, including slowing economic growth, low inflation, falling oil prices, and a growing willingness among investors to invest in bonds. As demand for bonds increased, bond prices were bid up, leading to a decline in yields.

How to buy 10-year Treasury bonds

You can purchase 10-year Treasury notes directly from the U.S. Treasury through Treasurydirect.gov. To do this, you’ll need a TreasuryDirect account, which you can open online for free. The minimum purchase amount is $100, and subsequent purchases must also be in $100 increments.

When buying directly from the U.S. Treasury, you’ll be participating in what is known as a noncompetitive bid. This means you agree to accept whatever price and yield the government is offering at the time of purchase. It’s a simple and straightforward way to invest in Treasury securities.

If you prefer to have more control over the price or yield, you can opt for a competitive bid. To do this, you’ll need to purchase through a bank, broker, or dealer. Keep in mind that while a competitive bid might lead to a better price or rate, it doesn’t guarantee that you’ll get the exact securities you desire.

However, with a noncompetitive bid, you are guaranteed to receive the amount of securities you purchase. So if having the exact quantity of securities is a priority, this might be the better option for you.

When purchasing a newly issued security through TreasuryDirect, there is a holding period of at least 45 days, unless you funded the purchase with the proceeds from a mature Treasury security. After this holding period, you have the option to transfer the security to another brokerage account or sell it if you wish.