The Significance of the Ten-Year U.S. Treasury Note (Bond) for Investors
AI's response in regular print | Beverly Hills, CFP®, Joe O'Boyle's in italics
“Why is the 10-Year U.S. Government Treasury Note (Bond) so important and what does the 10-Year Treasury Note (Bond) trading around 4% mean for investors?”
The United States Treasury sells Bills, Notes, and Bonds:
The U.S. government needs money to do things like build roads, schools, and parks. By selling T-Bills, T-Notes (including the 10-year), and T-Bonds, the government can borrow money from people and promise to pay them back later. Investors buy T-Bills, T-Notes and T-Bonds because they trust the U.S. government to keep its promise to pay them interest and pay them back in full. The government can raise taxes and print money to pay back investors.
While the U.S. Treasury does make distinctions between bills, notes, and bonds based on their maturity lengths, in everyday conversation and even in financial markets, people often refer to Treasury notes, including the benchmark 10-year Treasury note, simply as "bonds." Consequently, we will refer to it as the “10-year Treasury bond” going forward even though it is technically a “10-year Treasury note”.
Here's a simplified explanation:
Treasury Bills: These are short term bonds that last less than a year. Treasury bills are sold at a discount to their face value, meaning they provide investors with returns by paying them back at the full (not discounted) rate.
Treasury Notes: These are medium-length bonds that last between 2 and 10 years. They are sold as 2, 3, 5, 7 and 10 year notes. The 10-year Treasury note is the most well known. They pay interest every six months and return their face value at maturity.
Treasury Bonds: These are long term bonds that last more than 10 years, usually 20 or 30 years. They pay interest every six months and return their face value at maturity.
The Significance of the Ten-Year U.S. Government Treasury Bond in Investing
The financial markets are filled with various investment options, and one of the most crucial indicators for investors is the ten-year U.S. Government Treasury Bond which serves as a benchmark for various financial instruments and plays a significant role in shaping investment strategies. We will explore the importance of the ten-year Treasury bond and what it means for investing, particularly when the bond is trading around 4% where it is today (as of 8/1/23).
When you buy a ten-year U.S. Treasury bond, as the investor, you are effectively loaning this money to the U.S. government at an agreed upon interest rate. Think of yourself as the bank making a loan, but you’re the one receiving the interest. At the time of this writing, that ten-year interest rate is 4%. For example, if you buy a ten-year Treasury bond today for $10,000, you are effectively loaning the U.S. government $10,000 for ten years. You will be paid 4% per year (or a total of $400 per year) in interest for 10 years and then at the end of the 10 years you will receive your initial $10,000 back.
Understanding the Ten-Year Treasury Bond:
The ten-year Treasury bond is issued by the United States Department of the Treasury. It has a fixed interest rate and matures in ten years. Investors who purchase these bonds lend money to the government and receive regular interest payments over the bond’s life (interest is actually paid every 6 months). The bond’s price and yield are inversely related – as the price of the bond increases, its yield decreases, and vice versa.
Think of a children’s see-saw, as bond interest rates (yields) go up, bond prices go down. As bond interest rates (yields) go down, bond prices go up. They move in opposite directions (move inversely) like a see-saw. This is bond math and is where most people’s heads explode.
Perhaps a simple way to think about it is if you locked in your 10-year Treasury bond at 4%, but interest rates rose and are now paying 6% in the marketplace, your 10-year Treasury bond is no longer very good. You’re getting 4% interest while everyone else who buys a new 10-year bond is getting 6%. So you want to sell your 10-year bond before it matures (before your 10 years are up), but to do so you would have to sell it for less than the amount you bought it for (the price went down because the interest rate in the marketplace went up). You sell it at a loss.
Importance of the Ten-Year Treasury Bond:
a) Risk-Free Rate: The ten-year Treasury bond is considered a risk-free rate, because it is backed by the full faith and credit of the U.S. government. It serves as a reference point for determining the minimum return investors should expect when taking on higher-risk investments. For example, if you can get 4% “risk-free” for buying the ten-year Treasury bond today, then any other long-term investment that you will make needs to return better than 4%. Otherwise, you would just buy a ten-year Treasury bond.
b) Economic Indicator: The yield of the ten-year Treasury bond often reflects the overall health of the economy. When the economy is booming, yields tend to rise as investors sell Treasuries and go seek higher returns from riskier assets (such as stocks). Conversely, during economic uncertainty, investors flock to the safety of Treasury bonds, causing yields to fall. When investors are worried, they might buy more 10-year Treasury notes because they're safe. More buying drives the price up and yield down. Lower yields might mean lower interest rates for mortgages and car loans, making it cheaper for people to borrow money thereby potentially stimulating the economy.
c) Benchmark for Loans: The 10-year Treasury note is considered one of the safest investments because it's backed by the U.S. government. Because of this safety, the yield (or interest rate) on the 10-year Treasury often serves as a benchmark for other long-term interest rates, including mortgage rates, car loans and other corporate borrowing costs.
The 10-year Treasury yield is like a signpost that banks, lenders, and investors use to figure out what interest rates should be for various loans. It's connected to the big picture of the economy, and changes in this yield can make borrowing more or less expensive for everyday people. If you're looking to buy a house or a car, the interest rate you'll pay for your mortgage or car loan is influenced by the 10-year Treasury yield. If the yield is high, you might pay more in interest. If it's low, you might pay less. It's a key piece of the puzzle that helps determine how much money people pay when they borrow.
The Impact of a 4% Treasury Bond Yield on Investing:
When the ten-year Treasury bond is trading around 4%, it signals several implications for investors:
a) Opportunity Cost: A 4% yield on Treasury bonds suggests a relatively stable and low-risk investment option. Investors looking for higher returns might seek riskier assets like stocks or corporate bonds. The decision to invest in Treasury bonds depends on individual risk tolerance and financial goals.
b) Bond Market Performance: A 4% yield also affects the broader bond market. As Treasury bond yields rise, the prices of existing bonds with lower yields may decline, potentially impacting bond portfolios’ value. The specific impact will depend on factors such as the bond's maturity, credit quality, and type.
c) Impact on Stock Market: A higher yield on Treasury bonds can lead some investors to move their money away from stocks and into Treasury bonds. As Treasury bond yields rise, some may find the allure of safer investments more attractive, potentially causing stock market declines.
d) Diversification: A Treasury bond yielding 4% can be a valuable component of a diversified investment portfolio. Balancing riskier assets with the stability of Treasury bonds can help manage overall portfolio risk.
Ten-Year Treasury Yields | Historical Ranges:
The long-term average for the ten-year Treasury yield is 4.25%.
The ten-year Treasury yields all time low was 0.50% in March 2020 (due to the pandemic) while the all time high was 15.84% in September 1981. Since 2000, ten-year yields have generally traded “lower for longer” with yields generally somewhere between 2% and 4% (with the pandemic low as the exception).
Below is a breakdown of the ten-year Treasury yield by decade:
1960s: The 10-year Treasury yield started the decade around 4%, rising to nearly 7% by the end of the decade.
1970s: This was a period of great fluctuation, largely due to inflation and economic instability. The yields ranged from approximately 6% to a high of around 15% at the end of the decade.
1980s: The early '80s saw the highest yields on record, peaking at 15.84% in September 1981. Then, a long downward trend ensued throughout the decade, ending near 8%.
1990s: The yields continued to drop throughout the '90s, ranging from about 9% down to around 4.5% by the end of the decade.
2000s: This decade saw yields ranging from a high of approximately 6.6% down to a low of around 2.1% near the end of 2008, during the financial crisis.
2010s: The range was generally lower this decade, fluctuating between roughly 1.4% and 3.9%. The decade was marked by historic lows, especially in the second half, reflecting the persistently low-interest-rate environment globally.
2020s: The 10-year Treasury yield reached a low point of around 0.5% during the pandemic crisis in March 2020, rose to a high of 4.22% in October 2022, and is currently trading around 4% in August 2023.
Conclusion:
In conclusion, the ten-year Treasury bond holds significant importance in the financial markets and serves as a key indicator for investors. Its risk-free nature and influence on interest rates make it a vital benchmark for various investment decisions. When the Treasury bond is trading around 4%, investors should carefully consider their risk appetite and financial goals while incorporating this essential asset into their investment strategy. A well-balanced and diversified portfolio can help navigate the complexities of the market and position investors for long-term success.
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Joe O'Boyle is the founder and principal of O'Boyle Wealth Management, a full service financial planning and investment management firm, located in Beverly Hills, California. Joe O’Boyle was named to InvestmentNews 40 under 40 class of 2016, and has a catalog of financial planning and investing articles on Money.com & U.S. News. Disclosure information.