If you’ve ever taken an even passing interest in the stock market, you’ve probably heard about U.S. Treasury yields before. In January came frequent reports of 10-year and 30-year Treasury yields hitting new highs. Treasury yields play an important and understated role in the function of our financial systems — and your portfolio.
So, what exactly are Treasury yields? And how do they affect your holdings?
Treasury yields refer to the interest the U.S. government pays when purchasing a Treasury security, like a Treasury bond. Depending on the security, these assets may mature in anywhere from days to decades. Treasury securities are essentially loans to the government and are consequently one of the safest investments you can make.
10-year Treasury yields, in particular, tend to hog the spotlight, and for good reason. 10-year bond yields provide insight into a number of interrelated variables, including bond prices, mortgage rates, investor confidence, and more. This means that Treasury yields can provide insight into upcoming market conditions, or otherwise reflect current investor sentiment.
For example, in March 2020, the 10-year yield dropped to 0.54% as a result of more people buying Treasury bonds as the economy took a steep and uncertain nosedive. Bond prices and yields operate inversely, meaning that as bond prices increased due to higher demand, the yield they offered only continued to shrink.
This all begs the question, what do the currently elevated 10-year Treasury yields say about the state of the economy. And what do they mean for your portfolio?
Interest Rate Hikes Bring 10-Year Treasury Yields Back in Focus
The Federal Reserve’s impending interest rate hikes have been on every savvy investor’s mind. When the Covid-19 pandemic began, the central bank took numerous steps to ensure economic sustainability. This meant reducing interest rates to near-zero levels and buying up barrels of Treasury bonds to inject money into a quarantined economy.
Frankly, the government was largely successful in its mission. In 2021, the U.S economy enjoyed sky-high 5.5% gross domestic product (GDP) growth, wages increased even for low-end workers, and many of the largest companies in the Nasdaq Composite hit record-breaking share prices. In fact, some believe the Fed was a bit too successful. Inflation, which is directly related to GDP growth, has been rampant over the past year or so. While passed off as transitory, the Fed has announced plans to limit inflation by essentially slowing down the economy. This translates to limiting further stimulus payments, increasing interest rates, and tapering the purchase of bonds.
While most agree reducing inflation is a good thing, many investors are worried about the effects the tapering efforts will have on the economy. This fear has resulted in bizarre market conditions that have brought 10-year Treasury yields back into relevance.
The 10-year Treasury yield is currently sitting at roughly 1.96%, the highest its been since November 2019. Many suspect the yield is rising in relation to rising inflation concerns. With the economy’s red-hot growth last year despite a largely quarantined population, some have peddled doomsday theories of an impending stock market crash when the Fed finally hikes rates. The 10-year yield, however, paints a slightly different picture.
A high 10-year yield means investors are still demanding higher returns for their investments than what the Treasury offers. As such, the price of T-bonds has been quite low, while the yield has been surprisingly high.
What Do Rising Treasury Yields Mean for Your Portfolio?
Treasury yields are also considered the foundation for general interest rates. With the costs of borrowing expected to go up, it’s almost guaranteed that investors will see yields jump in anticipation. Some may read the rising long-term Treasury yields as investors demonstrating confidence in the Fed to sustainably hike rates. As such, bond prices have decreased, while Treasury yields have increased, as investors generally gravitate toward value stocks. While investors have panicked about the resulting selloff in tech stocks, they should take comfort in the reality that stocks still trump bonds. This means the shift to “risk-off” may not be as pronounced as investors fear.
It may seem easy to gloss over reports of minuscule shifts in Treasury yields, but when they change, so do many aspects of the economic landscape. Rising yields in particular present a uniquely terrifying possibility to investors. Should the yield grow too high, the stage could be set for a substantial stock market selloff as investors instead funnel their money into safer Treasurys. This could spell the end of whatever bull market Americans have been enjoying.
With that said, historically troublesome 10-year rates are closer to the 3% psychological level. But the 1.96% yield currently in play is actually quite a ways away from such a point. Depending on inflation expectations, the point where investors begin to look at Treasurys as a substitute for stocks will change. Should investors expect more inflation, which, despite the Fed’s plan is still the general consensus, the yield may have to hit 4% to present a comparable threat to the markets.
There may not exist a static roadmap for understanding 10-year Treasury yields, as they themselves are dynamic. Understanding the role Treasurys play in reflecting economic expectations and investor sentiment can dramatically enhance your understanding of financial markets, and facilitate better decisions for your portfolio.
On the date of publication, Shrey Dua did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
