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How Does the Treasury Curve Relate to Bonds?

Original post by Jonathan Langsdorf of Demand Media

The Treasury yield curve is a graphical representation of current Treasury security rates across the different maturities, from 30 days to 30 years. The curve shows investors what rate they will earn on government bonds at different maturity periods. The shape of the yield curve is also an indicator of future economic activity and interest rates.

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Treasury Securities

The market for Treasury securities is the largest debt market in the world. The U.S. Treasury issues trillions of dollars of bills, notes and bonds every year, and Treasury rates are used as the index or comparison rate of other types of bonds. The yield curve shows what the current rate is for Treasury securities at different maturities. For example, rates along the curve showed the one-year Treasury bill rate at 0.22 percent, the three-year Treasury note was paying 0.55 percent, seven-year notes were at 2.05 percent, the 10-year rate was 2.77 percent, and 30-year Treasury bonds were paying 4.07 percent.

Normal Curve

Investors look at the shape of the yield curve to see current rates for different maturities, and as an economic indicator. A normal yield curve has lower rates at the short maturity end of the curve, and the rates gradually get higher as bond maturities lengthen. The rates listed in the previous step would produce a yield curve with a normal slope. In an economy with normal growth expectations, investors expect to earn a higher yield if they are going to tie money up for a longer period of time in long maturity bonds. Short maturity securities are more liquid and pay lower rates.

Inverted Yield Curve

An inverted yield curve has short-term rates higher than long-term rates, and is a rare occurrence. An inverted yield curve existed in August 1981 when short-term bond rates were over 15 percent, and long-term bonds were paying 12 percent. An inverted yield curve occurs during periods of high inflation and a stagnant economy. The long end of the yield curve ends up with lower rates than the short-term end as investors buy long bonds to lock in the high rates associated with high inflation. Buying pressure drives up bond prices and pushes long bond rates lower.

Control of Rates

The shape of the Treasury yield curve reflects the actions of two different groups on the bond market. The Federal Reserve Board controls rates at the short end of the yield curve. The Fed sets the federal funds rate, off which most short-term rates including short Treasury rates are pegged. Long-term bond rates are the result of investor sentiment concerning future rates and economic activity. If the yield curve is steep, with long rates much higher than short-term rates, that indicates that bond investors believe economic activity increase. A flatter yield curve indicates a slower economy. Analyzing the yield curve works best if the changes in bond rates are viewed over an extended time period.


                   

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About the Author

Jonathan Langsdorf has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Langsdorf has a bachelor's degree in mathematics from the U.S. Air Force Academy.


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