On other hand, the US 10 year rate fell during the period of risk aversion and has remained low. The fixed income market is pricing in the scenario that there will be continue volatility and risk aversion.
US Yield Curve
The treasury yield curve is a chart of the yield of various maturities of US treasury bonds at a particular point in time. The higher rates at the longer end of the curve is a combination of the term structure premium and market expectation of future interest rates.
Term structure premium is the premium to compensate investors in holding longer maturity bonds verses short term bonds. The remaining spread to short term rates is the component that embodies the market expectation of the forward interest rate.
The chart above shows the US treasury bonds across the term structure today and twelve month ago. Comparing changes year on year highlight the changes in market outlook on the economy, interest rate and inflation outlook in the last 12 months. Whether the curve is higher or lower, it is more important to understand the underlying causes.
A higher curve could be an indication of an economic recovery where Fed will tighten monetary policy or a higher than expected inflation rate. Vice versa where a lower curve could be result of expected rate cuts due to economic slowdown. There are rules of thumb but to understand, one must look beyond the headline.
Market Impact of US bond yields
Each part of the curve can be useful in providing insight on the market expectation on future interest rates and outlook on the economy. However we have to stress that these are forecast by the action of market participates which does not necessarily mean it will be right.
The structure of the yield curve plays an important role in determining the relative value of currencies. The US treasury rate represent the yield on the US dollar. If the yield curve of the US treasury rate is higher relative to the yield curve of another currency, for example the Japanese Yen.
Then there is a natural pressure for the US dollar to appreciate. Hence a relative higher US yield curve have a degree of predictive power in the future US dollar to Japanese Yen exchange rate.
However it is important to note whilst important, it is a single factor in a number of factors that can drive exchange rates. Nonetheless it is important to keep an eye on it.
Key Treasury Rates
The shortest maturity government debt are called treasury bills. The bills are zero coupon securities which means that they do not pay interest rates but rather issued at a discount with a implied yield to maturity.
Those bonds range between 2 and 10 years are called treasury notes.
US 2 Year bond yield has been depressed and near zero since the financial crises. The rate on 2 year bonds or front end of the curve is the most sensitive to market expectation of actions by the Federal Reserve.
On the run 10 year treasuries are most liquid and frequently quoted proxy on the overall performance of the bond market.
The US 10 year bond rate is important because it is a critical input in the pricing of most credit products. It is also the most commonly used as the risk free rate in determining the risk premium in the discount cash flow models.
US 30 Year Bond Yield known as ultras is the longest maturity of issued US bonds. The key standout move is the US 30 year bond yield which have decline precipitously in the last 12 months. We see this as a negative indicator as a proxy for current expectation on the long run growth of the US economy.