Yield on 2 year US treasury bond was higher than that on 10 year bond, yesterday. Why?

Complicated relationship between yields explained

June 14, 2022 3:25 IST | India Infoline News Service
Yield on two year US treasury bonds touched higher than the yield on 10 year US treasury bonds yesterday. Treasury bonds are bonds issued by US Treasury or US government. Yield is the return that the bond gives to investors who are holding it. Suppose a bond with a face value of 100 gives annual interest rate of 8%.  The yield of this bond at the time it is first issued at $100 is 8%. Now two months after this bond was first issued, its market price is 98. It will give the same annual interest rate of 8%*100 (face value) = 8 to the investor. But now its yield is 8/98 = 8.16%. So yield and price of a bond move in opposite directions. An increase in yield means price of the bond has gone down in the market.

The yield curve is upward sloping usually. This means that a bond with a longer duration has a higher yield than the one with shorter duration. A 10 year US treasury bond should have higher yield than a 2 year US treasury bond. Yields of longer term bonds are usually higher because it is riskier to hold a bond for the longer term. So investors demand a higher return or yield for holding a longer term bond.

Then why yield on 2 year US trasury bonds touched higher than the yield on 10 year US treasury bonds? This is because the US Federal Reserve is all set to increase interest rate tomorrow. Now with increase in interest rate the value of all assets including financial assets such as bonds go down. Due to this expected interest rate hike, investors who held US 2 year treasury bonds started selling them. This sell-off brought down the price of 2 year US treasury bonds. Decline in price resulted in increase in yield. Sell-off was also there in the 10 year US treasury bonds but to a lesser degree than in the case of 2 year bonds. So the price decline in case of 10 year bonds was lesser. Actually 10 year bonds were selling at a higher price (lower yield) than 2 year bonds (higher yield).

Investors are expecting that once the Federal Reserve increases interest rate , it will slowdown demand in  the US economy further. This will bring recession. Once recession sets in the Federal Reserve will be forced  to lower interest rate to give a boost to demand in the economy. So the adverse impact of coming increase in interest rate will be more on the short term 2 year bond than on the long term 10 year one. Hence 2 year bonds traded at higher yields than 10 year bonds.

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