The Treasury Yield is the Oxygen of the Economy!

Many economists, investors, lenders, government agencies, corporations, and financial institutions closely monitor Treasury yields (government bond yields). But why?

First, let’s define what a Treasury yield is. It represents the annualized return that bondholders earn if they hold a U.S. government bond until maturity. These bonds serve as debt instruments issued by the U.S. government to finance both short-term and long-term operations. Large institutions and investors favor Treasuries primarily for their predictable returns. When institutions seek to balance their portfolios across (debt, equity, crypto, etc.) with low-risk assets or aim to preserve capital, U.S. Treasuries are often a preferred choice.

So, how are Treasury prices determined? When the U.S. government issues, for example, a $10 billion bond offering, two main types of buyers participate: noncompetitive bidders (individual investors) and competitive bidders (institutions). Noncompetitive bidders accept the yield set by the government (e.g., 3%), while competitive bidders specify the yield they are willing to accept. After they purchased them, these bonds can be traded in the market, where their prices fluctuate based on factors such as supply & demand, time to maturity, and yields of other securities issued by the U.S government. Please note that the U.S. government does not set bond prices once they enter the market.

What does it mean when people say, “The Fed is going to raise or lower interest rates”? This refers to the Federal Funds Rate (FFR)—the target interest rate range set by the Federal Open Market Committee (FOMC), the policymaking body of the Federal Reserve System (the Fed). The FFR dictates the rate at which banks lend and borrow money from each other overnight.

Since the Fed controls monetary policy, it can lower the FFR, reducing the cost for banks to borrow from the central bank and from one another. This, in turn, allows banks to offer lower interest rates to consumers and businesses. As borrowing becomes cheaper, demand for loans increases (including mortgages, business loans, and student loans), leading to more transactions, higher economic activity, and ultimately, economic growth.

Because of these dynamics, Treasury yields hold significant importance, influencing financial, investment, budgeting, and valuation decisions across various sectors.

Ahmed Almuhr