FINANCE TODAY | ISSUE NO.08
WHAT IS A TREASURY YELD AND WHY DOES IT MATTER?
Treasury yield is defined as the return on investment in the form of a percentage on the U.S. government’s debt obligations. Essentially, it is the effective interest rate that the U.S. government pays to borrow money for various lengths of time, each length having a slightly different rate 6. But its purpose does not end there: the reason treasury yields are so important is that they heavily influence the interest rates that individuals and businesses are obligated to pay when borrowing money. The U.S. government, similarly to a business or corporation, requires capital to fund projects such as building new infrastructure. To do so, it issues debt instruments through the U.S. Treasury. The instruments come in three forms: Treasury bills (T-bills), Treasury Notes (T-notes) and Treasury bonds (T-bonds), all with different durations increasing respectively. These investments are considered low-risk since they are backed by the credit of the U.S. government, and bring investors gains through interest payments as compensation for loaning the government money. The yield or rate of return on these Treasury securities that is required by investors is largely determined by demand and supply. As demand rises on these securities, the price goes up and they are sold past their face value which lowers the overall yield for investors. When demand is low, the yield shoots up to compensate for investors wanting it less. Additionally during low demand, investors generally will only pay an amount less than par value. Treasury yields are a major factor influencing interest rates across industries. As Treasury yields increase, interest rates in the economy also increase as the government needs to pay higher interest rates to attract more buyers in the future. Yields can also increase if the Federal Reserve tightens its monetary policy where it increases its target for the federal funds rate. This effect of Treasury yields spiking can even be seen if investors do as little as speculate that the fed funds rate is going to increase6.
TREASURY YIELDS UP THIS WEEK, STOCKS DOWN
This past Tuesday saw U.S. markets take a dive with almost every sector experiencing loss. The S&P 500 (ES=F) lost 90 points or 2%, settling at the end of the day down to 4,352.63. The Dow Jones industrial average (YM=F) fell 569 points or 1.6%, closing at 34,299.99. Tech-focused Nasdaq (IXIC) experienced the heaviest hit with a 423 point loss, equal to 2.8% and closing at 14,546.68, marking its worst day since March1. These major indexes have since fallen even further as the week went on, but this past Tuesday showed investors that there was trouble ahead. Of all the sectors, tech was hit the hardest with some of the biggest names such as Microsoft (NASDAQ: MSFT), Facebook (NASDAQ: FB), and Alphabet (NASDAQ: GOOGL) suffering losses over 3% halting their record-breaking growth on Wall Street since the start of the pandemic2. Tech giants Amazon (NASDAQ: AMZN) and Apple (NASDAQ: AAPL) also slipped 2.6% and 2.4% respectively. Tech and communications were at the blunt end but negative effects were felt by all sectors with the exception of energy. Over 50% of the S&P 500’s components had closed 10% or more below their 52-week highs, with 63 stocks falling 20% or more3. The drop experienced by the market this week is due largely to a speedy rise in the 10-year Treasury yield. On Tuesday, it went as high as 1.567% as investors anticipated that the Fed would keep its promise to stop its emergency bond-buying stimulus. Typically, whenever there is significant and rapid movement in the 10-year U.S. Treasury yield, there is some extent of market sell-off which would explain this week’s stock turmoil1.
WHAT ARE THE TECH STOCKS AT THE FOREFRONT OF THIS?
Tech stocks have been celebrating generous amounts of success during the pandemic thanks to shopping and entertainment widely going digital. However, the sector is especially sensitive to interest rates and part of its respectable onset of gains is due to the rates being held substantially low by various market stimuli2. The tech industry is considered to be high-growth, and as a result, a big factor affecting valuation is future cash flows which can be undermined by heightened interest rates. Revaluation of future free cash flows for a large technology corporation would make the corporation’s stock seem overvalued, creating strong selling pressure and feeding a decrease in stock price4. Other industries such as financial infrastructure are less prone to loss during interest rate hikes with banks even having the potential to benefit during conditions like these.
WHERE IS THE U.S'S ECONOMY HEADED?
Lots can be taken away from the happenings of this week, but all in all it’s safe to say that tough and unpredictable times are ahead for investors as interest rates climb and the Fed steps away from market stimulus. Fed leaders say that they want “substantial further progress” in terms of inflation and job growth before they make the move to ease out of their current supportive position for the market4. While general price increases seem to meet requirements for a healthy economic resumption, unemployment rates still stagger behind. The U.S. remains over 5 million jobs down from before the pandemic, but many seem optimistic that progress has been made and that a full recovery will happen in the coming months. Furthermore, several panelists from the National Association for Business Economics revealed on Monday that their outlook for economic growth for 2022 has improved since May. They forecast that the nation’s gross domestic product will grow by 3.5%, up from 2.8%5. With the Treasury yields already increasing at quick rates, investors are already betting that the Federal Reserve will remove some stimulus as early as by the year-end. Strategists predict that given these recent events, the Treasury yields in the near future will be “choppy” but will give way to even further growth by the end of the year5.
Shaban, H. (2021, September 28). Dow slides more than 500 points as Treasury yields hit three-month high. The Washington Post. Retrieved October 1, 2021, from https://www.washingtonpost.com/business/2021/09/28/stocks-today-treasury-yields/.
Jesse Pound, M. F. (2021, September 28). NASDAQ tanks 2.8% in worst day since March as yield spike hits tech stocks, Dow Drops 570 points. CNBC. Retrieved October 1, 2021, from https://www.cnbc.com/2021/09/27/-stock-market-futures-open-to-close-news.html.
Culp, S. (2021, September 28). Wall street swoons on rising treasury yields, growing inflation worries. financialpost. Retrieved October 1, 2021, from https://financialpost.com/investing/wall-st-tumbles-on-weak-consumer-sentiment-rising-bond-yields-2.
Culp, S. (2021, September 27). US stocks-tech pulls Nasdaq, S&P 500 down as Treasury yields rise. Yahoo! Finance. Retrieved October 1, 2021, from https://finance.yahoo.com/news/us-stocks-tech-pulls-nasdaq-202513344.html.
McKeever, V. (2021, September 29). 10-year Treasury yield falls slightly as Bond sell-off eases. CNBC. Retrieved October 1, 2021, from https://www.cnbc.com/2021/09/29/us-bonds-10-year-treasury-yield-eases-back-following-sell-off.html.
Chen, J. (2021, September 21). Treasury yield. Investopedia. Retrieved October 1, 2021, from https://www.investopedia.com/terms/t/treasury-yield.asp.