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Treasury Yields Fall on Bank of Japan’s Negative Interest Rates

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Secondary market

Treasury yields fell across the yield curve, except for three-month, six-month, and one-year Treasury bills, after the Bank of Japan introduced a negative interest rate for the first time on excess reserves to prop up the economy. Another reason for the decline in yields was the weak durable goods order data pointing to slow growth in the US economy. The yield on the benchmark ten-year note ended at 1.9%, falling by 13 basis points from the previous week.

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Federal Open Market Committee policy meeting

The two-day Federal Open Market Committee meeting ended on January 27, 2016, and the Federal Reserve left the interest rate unchanged at 0.25%–0.5%, as was widely expected due to the oil price rout, the global slowdown, and volatility in the equity market. The dovish statement by policymakers diminishes the probability of a rate hike in March 2016.

Bank of Japan surprised the market

On January 29, the Bank of Japan surprised the market by introducing a negative interest rate in a move to come out of the deflationary environment and to foster consumer spending. This move won’t affect individuals directly but could affect financial institutions.

The cash currently held at the central bank will continue to earn the same 0.1% interest rate. However, required reserves will earn zero interest now, and the funds in excess of reserve requirements will earn a -0.1% interest rate.

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Economic indicators

In the fourth quarter of 2015, the US gross domestic product, or GDP, grew at an annual rate of 0.7%, down from 2.0% recorded in the previous quarter. Meanwhile, the core PCE (personal consumption expenditure), which excludes food and energy prices, slowed to 1.2% during the fourth quarter on a year-over-year basis from 1.4% in the third quarter. Core PCE is the Fed’s preferred inflation measure of domestic inflation.

Pending home sales rose marginally by 0.1% on a month-over-month basis in December. In 2015, they rose by 3.1%, down from the 4.9% rise in 2014. Pending home sales were down in 2015 due to the slump in the manufacturing sector. Home sales affect homebuilders and home improvement companies such as Lennar Corporation (LEN), PulteGroup (PHM), D.H. Horton (DHI), and Home Depot (HD).

Investment impact

A fall in Treasury yields across the yield curve led to a rise in mutual fund returns, as prices and yields are inversely related.

Week-over-week, the Dreyfus US Treasury Long Term Fund (DRGBX) and the Wasatch-Hoisington U.S. Treasury Fund Class A (WHOSX) both rose by 1.3%.

Several Treasury note auctions took place last week. As we move through this series, we’ll look at them in detail beginning with the auction of seven-year Treasury notes.

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