Stock markets stumble as US Treasury bond yields hit 3%
Liam Sheasby, News Editor
25 Apr 2018, 5:16 p.m.
Stock markets across the world are suffering after the US Treasury’s latest figures showed its 10-year bond yields have reached 3% - a milestone not seen since 2014 and dubbed “psychologically important” by analysts as the first real test of the stock markets since their record levels in January.
Bonds are a secure investment due to governments guaranteeing repayment, and it’s this lack of risk that is stealing attention away from stocks and shares. Bond yields often act as a precursor for inflation too, which then result in interest rates rising. The expectation of rate rises is driving demand, with investors hoping to capitalise on good yield rates.
What is the 10-year yield?
The 10-year yield is the returns made on a US Treasury bond, or a UK treasury gilt. You buy a bond from the government, you pay them a fee (say £1000), and then over the 10 years you will receive interest payments back to you – the yield. At the end of the 10 years you then receive your initial investment back.
Based on the current 3% yield, an investment of £1000 would pay you £30 a year, meaning a total of £1300 received by the end of the decade.
Why is the 10-year yield rising?
Treasury bonds are yielding higher returns due to a combination of a lack of interest in the US government’s bonds, and to account for inflation. The current administration plans a large amount of infrastructure work across the USA and needs funds. By borrowing via these treasury bonds, they can raise the funds, do the work, and use the profits of their work to repay the initial investment. Inflation has led to the US Treasury selling these bonds slightly below their true value (below par) to offer a better deal or yield to investors.
In related news, the 2-year Treasury note yields also hit 2.5%, a first since September 2008. The 0.5% difference between the 2 and 10-year bonds is a cause for concern, as usually the short-term investments are less risky. When the gap closes like it has it’s known as a Flattening Yield Curve. If this trend continues and the gap does close then it becomes an Inverted Yield Curve – an event that usually precedes recession.
The 10-year Treasury Bond yields chart. Image courtesy of Macrotrends.net.
Why do the bond yields hurt stocks?
As mentioned before, yields rising makes stocks less attractive because government bonds are far safer an investment, given they have a guaranteed return. The shift in where to invest is already visible, with the Dow Jones down over 424 points as Tuesday’s trade closed, while the S&P500 was also down just shy of 1.5% in value.
The FTSE 100 today is down just over 50 points, which is more modest, but the yield impact has made the Dollar stronger. A stronger Dollar makes for a weaker Pound, and foreign investors like the UK currency weaker so it maximises their profits made on the London Stock Exchange when converted into Sterling. As such, it was expected that the FTSE wouldn’t suffer too much.
With higher interest rates comes a higher cost of borrowing (mortgages, e.g.) but for businesses this restricts room to invest, to raise salaries, and to give back to shareholders. Investors like profit, so instead they turn away from the underperforming stocks to the bonds themselves, or other investment opportunities like gold and silver billion.
Is there any risk with treasury bonds?
There are risks down the line. With higher yields come higher repayments. The US government can only afford so much debt service. Compensating for inflation is raising their debt obligation, and even if they raise interest rates to tackle inflation, this keeps bonds and their yields desirable. The ideal scenario is that demand snowballs, meaning the Treasury can sell bonds at a premium (thus reducing the yield rate) knowing they will sell.
Given the recent Bank of England backtracking on expected interest rates it’s not unimaginable to think that the Federal Reserve could do the same. With no rise in rates, the Dollar and bonds would continue to devalue under inflation, even if they are a safer investment than stocks and shares.
Which is better: gold bullion or Treasury bonds?
Choosing one investment option or the other is subjective, as both are safe forms of investment. Treasury bonds have government backing and they can offer – if bought at the right time – a solid return on your investment. The issue is the time period involved to realise your returns.
In comparison, gold doesn’t accrue interest. It’s a way of preserving wealth. It counters the process of devaluation caused by inflation. Gold thrives in periods of Negative Real Interest Rates, where interest rates are climbing at a slower pace than inflation. You can have the gold in your physical possession, and it’s arguably easier to trade your investment bullion and take advantage of the metal markets than it is to sell your bonds early. There are many approved refiners on the market, with organisations like the LBMA helping verify their quality.
Timing is everything. Getting a good yield rate on a treasury bond or gild is a smart investment, but if you arrive at the wrong time you could end up paying a premium on your investment. The same applies to gold and silver. When a currency is doing well the price of gold is lower as the buying power of that currency is greater. When the currency falls down in value then its comparable rate to gold changes, and gold per ounce grows in value.