Must-know drivers that impact Treasury yields and ETFs like TLT

By

Updated

What is yield?

Yield is the annualized return on investing in a bond, considering both coupon payments and redemption value (normally the face value). Like all other returns, bond yields are quoted in percentages.

Treasury yield curve

For Treasury securities, yield is determined by economic conditions and the Fed’s monetary policy. When the economy is on a downturn, investors prefer to park their funds in safer avenues, such as Treasury securities and bullion (gold and silver). Plus, the Fed tries to boost capital investments and consumption during a downturn by lowering the Fed funds rate and increasing the money supply. The flight to safety, coupled with the low interest rates and higher money supply, lifts bond prices.

Article continues below advertisement

Interest rates and bond prices share an inverse relationship. When interest rates decline, Treasury securities and related ETFs such as the iShares Barclays 1–3 Year Treasury Bond Fund (SHY), iShares Barclays 7–10 Year Treasury Bond Fund (IEF), ProShares UltraShort 20-Year Treasury (TBT), iShares Barclays 20-Year Treasury Bond Fund (TLT), and iShares Barclays 3-7 Year Treasury Bond Fund (IEI) gain.

Corporate and agency bonds typically price as the corresponding Treasury yield plus a credit spread, as investors seek higher returns from corporate and agency bonds to compensate for the higher risk of default (credit risk) in those bonds.

In an economic downturn, Treasury yields fall but the credit spread rises as corporate profitability plummets. During the boom phase, interest rates start rising but the credit spread contracts due to a favorable operating environment for corporations.

To learn more about why yields on securities that differ only in maturity can vary so widely, read on to the next part of this series.

Advertisement

More From Market Realist