US Federal Reserve, in an emergency move, decided to slash interest rates by 50 basis points. This threw the 10-year US Treasury Bond into a spiral as its yield dipped to its historical low of 0.914%. The emergency move to calm consumer sentiments amidst fears of Coronavirus could only be a disguise to the hinted slowdown in the US economy after the yield curve inverted in 2019. Some say this is an important rejig for the markets and an opportunity for the investors to reorganize their portfolio.
Crux of the Matter
United States Federal Reserve announced an interest- rate cut of 50 basis points (1 basis point = 0.01%) or half percentage – now ranging at 1-1.25% – to match the consumer sentiments amidst the scare of Coronavirus. This emergency cut is the first big such cut since 2008 Global Recession. This rate cut coupled with bullish consumer sentiment pulled the 10-year US Treasury Bond yield below 1% for the first time in history.
What is US Treasury Bond Yield? A Treasury Bill or Note is government-backed security that pays interest over time. The gain that a person has on holding the security for a certain period and at a certain interest rate is called yield. Treasury Bills usually mature in less than a year, whereas Treasury Notes usually mature in a period of 1 to 10 years. A Treasury Bond matures in more than 10 years. Treasury Bonds are fully-backed by the government and hence are considered the safest investment.
Why is it Important? The yield of the 10-year Treasury Bond is used as a benchmark or even proxy for various loans and interest rates in the US. This security also acts as a barometer of the consumer confidence index. These bonds are auctioned by the government of US. When the general investor confidence in a country is high, meaning that the consumers or investors can find high returns on investment, a safe bet like the T-Bond does not appeal to them. Henceforth, the demand for the bond goes down, and so does the price.
Rate (in %) of 10-year US T-Bond (All-Time) Source: Trading Economics
Bond Yield and Bond Price have an inverse relationship. The decrease in bond price increases the yields. In this situation, the demand for the bond is low, and the government needs to offer a higher interest rate on the bond, thereby increasing the yield on the bond. On the other hand, when bond prices go up, the yield goes down. The bond is already in demand, and the government does not need to incentivize the investors by providing high interest on the bond. The demand for a T-Bond may start increasing because the investors do not have much confidence in other securities and consider this government-backed Bond a safe haven. A 100 basis point or 1% change in the yield of the bond is considered significant and may be indicative of changing economic landscapes. It is important to look at the rates in the context of the historical trends so as to mitigate any risks and save the financial markets from collapsing.
The 10-year US T-Bond is analogous to benchmark security. A rise in its yield would also mean that the interest rates on business and consumer loans of similar and benchmark period would rise. This is because the 15-year mortgage loans, student loans, or other loans have the yield of 10-year T-Bond as their benchmark.
10 & 2 year US Treasury Bond Yield Curve Inverted on 12 August 2019
It must also be noted that the 10-year US T-bond yield was lower than the 2-year US T-Bond in 2019. Generally, the yield on the longer-term bonds must be higher than short term bonds. The 2019 phenomenon is called an inverted yield curve. Before every recession, US yield curve has inverted and many predicted that the US and the world economy might go through a slowdown in the coming times.
Unprecedented Lows in the US Economy US economy could not contain the impact and the fear of sluggish global economy and the spread of Coronavirus. Right after the Federal Reserve announced half a percent cut in interest rates, the Dow Jones came crashing down. In the same trading session, the 10-year US Treasury Bond touched a low of 0.914%. Albeit regaining the 1% mark, the dip in the benchmark security raises the question of whether the US economy was already expecting this downfall as the negative impact of the Federal Reserve rate hike. US economy also witnessed the inversion of the yield curve in 2019 and this adds to the fear that the COVID-19 outbreak is spreading.
Ripple Effect As the ripple effect of the 10-year T-Bond yield drop, markets across the world slowed down. Yields on Australian and South Korean short-term bonds dropped by 10 basis points. Indonesia’s 10-year bond yield dipped by 25 basis points. Indian bond market also saw an 8 bps drop. However, Indian rupee that has depreciated nearly 2.5% this year itself, is expected to remain strong with the Fed Res rate cut.
Real 10-Year Bond Yields (yield minus inflation)… China: -2.5% Poland: -2.4% Austria: -2.3% Germany: -2.2% Netherlands: -2.2% France: -1.7% Belgium: -1.6% Ireland: -1.5% Sweden: -1.5% Finland: -1.3% UK: -1.3% India: -1.2% Canada: -1.2% Denmark: -1.2% US: -1.2% Swiss: -1.0% pic.twitter.com/caCYEJwdE3 — Charlie Bilello (@charliebilello) February 25, 2020
Investors See an Opportunity As the 10-year T-Bond is seen as benchmark security, the interest rate on mortgage loans and other loans is likely to fall. If a consumer is planning to buy a home, the mortgage loan -which is one of the costliest in US – may be expected to come down if the bond yield hovers around 1%. Education Loans, which is another costliest loan in the US, could become significantly cheaper if the yield remains lower. The rejig of Bond Yield Curve also affects the fair value of all asset classes like equity stocks, commodities, and currencies. Some investors believe that this valley in the time of the market could be an opportunity to reshuffle or upgrade the portfolio.
Curiopedia
Yield curve is a curve showing several yields to maturity or interest rates across different contract lengths (2 month, 2 year, 20 year, etc. …) for a similar debt contract. The curve shows the relation between the (level of the) interest rate (or cost of borrowing) and the time to maturity, known as the “term”, of the debt for a given borrower in a given currency. The U.S. dollar interest rates paid on U.S. Treasury securities for various maturities are closely watched by many traders, and are commonly plotted on a graph such as the one on the right, which is informally called “the yield curve”. The slope of the yield curve is one of the most powerful predictors of future economic growth, inflation, and recessions. One measure of the yield curve slope (i.e. the difference between 10-year Treasury bond rate and the 3-month Treasury bond rate) is included in the Financial Stress Index published by the St. Louis Fed. An inverted yield curve is often a harbinger of recession. A positively sloped yield curve is often a harbinger of inflationary growth. More Info
Curated Coverage
CNBC – The inverted yield curve explained and what it means for your money
Economic Times – How Fed rate cut changes equation for Indian money market, treasuries
The Straits Times – Fed’s rate cut drags bond yields to all-time lows across Asia
CNBC – 10-year Treasury yield north of 1% amid Biden victories, government coronavirus actions
Economic Times – Recession fears in US spike as yields hit record lows
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