Impact on Treasuries
Monetary policy announcements are significant events for the fixed-income market. For the fixed-income market, the policy is a direct signal for the country’s key interest rate. Although a central bank can’t force commercial banks to make changes to their rates based on its signal, it can strongly indicate where it would like interest rates to be.
The Reserve Bank of India’s (or RBI) monetary policy announcement will impact US Treasuries. Let’s learn more in this part of the series.
The policy announcement can impact the interest that the money in your savings account earns. It can impact your loans that have a flexible rate. It will also impact you if you’re planning to take a loan—whether its a fixed rate or flexible rate.
Apart from the above, these announcements directly impact fixed-income exchange-traded funds (or ETFs) like the iShares 20+ Year Treasury Bond (TLT), the iShares Barclays 7-10 Year Treasury Bond Fund (IEF), the Vanguard Total Bond Market ETF (BND), the iShares Core U.S. Aggregate Bond ETF (AGG), and the iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD).
Case in point
A plot of interest rates across maturities—or tenors—at a point in time is known as a yield curve. The yield curve should contain securities with the same credit quality. Since US Treasuries are issued by the US Fed, they have sovereign backing. As a result, they have the highest quality.
The graph above shows you how US Treasuries react to a mismatch between market expectations and the Fed’s action. In its September 2013 announcement, markets were expecting a rollback of stimulus measures taken by the Fed. However, the central bank didn’t make an announcement.
US Treasuries with maturities of three to 20 years fell by over ten basis points (or bps) in one day. Specifically, the five-year, seven-year, and ten-year securities declined by 19 bps, 21 bps, and 17 bps, respectively. The reference to the yield curve on December 2, 2014, is just to compare the yield curve then and now.
In the next part of this series, we’ll explain how equity investments are affected by changes in interest rates.