There has been plenty of volatility in all markets over the last few months to accompany market events that have dominated the headlines. Everybody, from the Risk Averse investors to Investment Analysts have something to add to the debate on what way markets will move next. This I believe is positive and is bringing people back to focusing on how the economy functions. The focus of this blog is not to call the market, but to discuss some of the important terminology being used in the financial press. I will outline the importance of the US 10 Year Treasury Yield and why it is the graph to watch, available by clicking here. Final notes address an increasing yield from a national and individual perspective.
Bonds are debt investments, investor loans currency to a Government or Company for a specified period of time. Bonds are broken into two categories: Sovereign Bonds which are issued by countries and Corporate Bonds are issued by companies. This blog will focus only on Sovereign Bonds, these are issued by countries as a means of raising capital. When we hear of increase in National Debt this has been raised through the issuing of short and long dated bonds (generally up to 30 years). The capital raised is added to the Revenue generated through taxation to fund the nation’s liabilities.
Sovereign bonds are backed by the government of the issuing nation, therefore the return is also known as the “risk free rate of return“ when issued by nations that hold credit worthy ratings. To view the list of ratings issued by S&P, Fitch and Moody’s please click here. Sovereign bonds are contracts issued by a country agreeing to pay back the borrowed sum at a set date in the future. In addition to returning the initial borrowed amount the issuer agrees to pay the borrower a fixed interest periodically, see the US current rates here. The fixed interest rate attached to the bond is also known as the yield. The yield refers to the interest that will be paid by the government on borrowed currency. Bonds Prices and Bond Yields are inversely related. This means that when the yield rise the capital value or price drops and vice-versa.
The US 10 Year Treasury Yield importance should not be understated. This is as an economic indicator used by investors in the market to determine current and future investment possibilities. The yield is often used as an indicator of overall financial stability of the market. The 10 year yield reflects the market’s opinion on where rates are going and is also a guide for almost all other interest rates. This indicates effects consumer confidence in future economic performance and market liquidity.
Yield of the US 10 Year Treasury dropped to a low of 1.357% on 8 July. The yield then increased to hit its year high closing on 18 November 2016 at 2.35%. Although a year high may not sound like a factor to be overly concerned about, when the low of 1.357% was a mere 19 weeks previous, this 1% change in yield should raise a few eyebrows! This higher yield suggests reduced liquidity in the market. Increasing yields mean the following:
- An increase in the current Treasury yield means that the new debt is issued and fixed with an increased rate attached to the Bond for the term of the contract. As a result of the increase in yield, funding future liabilities by issuing debt will be at an increased cost. The Securities Industry and Financial Markets Association(SIFMA) publish data on the issued US Treasury debt and the rates attached to the contracts are available here.
- For an Individual the cost of borrowing will increase when yields rise on both secured and unsecured debt. This was discussed in a recent blog available by clicking here. It would be prudent to implement a buffer when agreeing your repayment levels on new debt, to factor in possible changes in interest rates.
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