The 10-Year yield, why we put it under the microscope

The global news broadcasts on any TV are always looking at the benchmark indexes, major currencies, commodities, and treasuries. Every morning we get swamped with numbers in the finance segment, the little clip of treasuries is often included giving a simple update on a market that many find complex areas to digest. The most commonly looked at is the yield on 10-year Treasury notes.

To understand why the US 10-year yields are so closely looked at, its important to know what they are and why they matter. Treasuries, in simple terms, are debt from the US government. Think of it as a bank loan, except instead of you going to the bank for the loan, you are the bank, and the government comes to you. When a budget deficit is in effect, treasuries are offered to investors to help the government fund spending activities that revenue has been unable to supply. The yield is the interest, the amount as a percentage that the government will pay you for lending them the money.

Like a bank loan, treasuries have different lengths of maturity, some can be as little as a few days, but they can range up to 30-years. The other duration of bond terms can be looked at differently, almost like a barometer of economic health. Short term treasuries tend to be more susceptible to changes made to the financial ecosystem by the federal reserve. Long term treasuries such as the 30 years offer a guideline for growth, but generally, the duration is too long to be helpful; a lot can happen in 30 years.

The 10-year treasury receives a lot of attention from all walks of life, it is used to price other assets and even other treasuries, but to us, as traders, it offers itself as a tool of measure, a ruler of sorts. We can use the 10-year treasury, which has relatively low-risk parameters and simplified return outlooks, to compare riskier asset classes and the viability of taking on more risk.

Therefore, fluctuations in the 10-year yield pose a problem; it means that the measure for comparison becomes skewed and makes performing that valuation more difficult. It also poses a problem for stocks markets; the higher the yield from a government loan is, the more unattractive stocks become. In companies that are valued on future cashflows like much of the tech sector, it creates a more significant challenge by heavily discounting the value of their potential revenue.

The focus in markets is on inflation and growth, and the Feds constant dovish tone has some traders concerned. The fed has gotten it wrong before on policy surrounding treasuries; the last time was in 2014, where proposed rate increases did not match analyst expectations, and the market listened, and eventually so too did the fed. We could very well be in the middle of a similar scenario, the fed has indicated that low rates will remain until the end of 2023, but analysts have pushed up their expectations by more than a year.

With 10-year treasuries seeing volatility, it has drawn even more attention to inflation, the fed, stock markets and yields. This phase of the market scrutinizing every move in yields is likely to continue until we see direct action from the US federal reserve. Eventually, the market will get what it wants, but the time horizons are misaligned. Both the fed and the market want the same thing, and one just wants it earlier than the fed wants to give it up.