US Treasury Yields - BondEvalue

US Treasury yields refer to the yield or the return on US government bonds, which are commonly referred to as Treasuries. US Treasury yields are one of the most important metrics that investors across the globe track closely. The reason for this is because the US Treasury yields are the benchmark for the risk-free interest rate on all US dollar denominated borrowings, given that Treasuries are backed by a guarantee from the US government, which carries the highest credit rating of AAA.

Before we get into why US Treasury yields are important, it is critical to understand how US Treasury yields move. Since they are considered a risk-free security, investors tend to buy US Treasury bonds in times of uncertainty. In contrast, if the economic environment is strong, investors would sell US Treasury bonds and buy riskier assets such as equities, corporate bonds or commodities. Demand for US Treasury bonds drives its prices – strong demand drives prices higher and vice versa. Since prices and yields move in opposite directions, higher Treasury prices lead to lower yields and vice versa.

Why are US Treasury yields important?

• Benchmark for USD borrowing

The interest for all US dollar borrowings, whether by individuals or corporations, is determined based on US Treasury yields. For example, if a BBB-rated corporate would like to issue a 10-year US dollar bond, it would have to offer a yield of 10 year Treasury yield plus a credit spread. The credit spread is the incremental interest that it would have to offer to incentivize investors for holding its bonds, given the credit risk associated with its bonds. As one may expect, the credit spread is inversely related to the corporate’s credit rating – higher the credit rating, lower the credit spread and vice versa.

• Indication of investor sentiment

The change or movement in the US Treasury yield gives a sense of investor sentiment. If the US is witnessing strong economic growth, it is reasonable to expect its equity and bond markets to rise, all else remaining equal. In such a scenario, investors would want to move out of US Treasuries and move into equities and bonds. Selling Treasuries would lead to a fall in its prices and a rise in its yields. On the other hand, if investors expect the economy to contract, it is reasonable to expect its equity and bond markets to fall, all else remaining equal. To avoid a depletion of their capital, investors would switch out of equities and bonds and switch into US Treasuries. This is why Treasuries are commonly known as a “safe haven” asset as it offers safety and security against economic uncertainty. Buying Treasuries would lead to a rise in its prices and a fall in its yields. Thus, investors can predict whether the market is pricing in strong or weak economic growth based on the direction of US Treasury yields.