how treasury yields are determined
treasuries are viewed as the lowest risk investments because they are backed by the full faith and credit of the u s government investors who purchase treasuries are lending the government money the government in turn pays interest to these bondholders the interest payments known as coupons represent the cost of borrowing to the government the rate of return or yield that investors receive in return for lending money to the government is determined by supply and demand treasury bonds and notes are issued at face value the principal the treasury will repay on the maturity date and auctioned off to primary dealers based on bids specifying a minimum yield if the price paid for these securities rises in secondary trading the yield falls accordingly and conversely if the price paid for a bond drops the yield rises for example if a 10 year t note with a face value of 1 000 is auctioned off at a yield of 3 a subsequent drop in its market value to 974 80 will cause the yield to rise to 3 3 since the treasury will still be making the 30 1 000 x 03 annual coupon payments as well as the 1 000 principal repayment conversely if the same t note s market value were to rise to 1 026 the effective yield for a buyer at that price would have declined to 2 7 treasury yield curve and the fedtreasury yields can go up sending bond prices lower if the federal reserve increases its target for the federal funds rate in other words if it tightens monetary policy or even if investors merely come to expect the fed funds rate to go up the yields on the different treasury maturities don t all rise at the same pace in such instances because the fed funds rate represents the rate banks charge each other for overnight loans it most directly affects the shortest term treasury maturities the prices and yield of longer term maturities will be more reflective of investors longer term expectations for economic performance in past instances of fed rate hikes short term yields have typically risen faster than longer term ones as bonds priced in investor expectations of slowing economic growth in response to the fed s policy normally longer term treasury securities have higher yields than shorter term ones that s because the longer duration of those securities exposes them to more of a risk if interest rates rise over time however in advance of recessions the rate structure of treasury yields often called the yield curve can invert that happens when the yields on longer term treasuries fall below those on short term ones as they price in investor expectations of an economic slowdown an inverted yield curve on which the yield on the 10 year treasury note has declined below that on the two year treasury note to cite just one popular benchmark has usually preceded recessions though it has also provided a few false alarms 12