Why Do Treasury Yields Rise and Fall?

Treasury yields can move in many instances -- after an inflation report, during a Federal Reserve announcement or on a day with no major economic news. Headlines often focus on whether yields rose or fell. Understanding what drove the move takes a closer look.

Our previous article, 10-Year Treasury Yield: What It Is and How It Can Affect Stocks, covered some of the basics. Here, we take a closer look at what causes yields to change and why similar moves can mean different things for the broader market.

It Starts With Prices

Treasury securities are debt issued by the U.S. government. After they are issued, investors can buy and sell them in the market.

For a Treasury note with fixed payments, its price and yield move in opposite directions. Paying less for a note with the same remaining payments provides a higher yield. Paying more for the remaining payments means a lower yield. A rising yield does not mean an existing fixed-rate note suddenly pays more interest.

That distinction also explains why Treasury prices can fall. Investors who sell before maturity may receive less than they paid, even though the security is backed by the U.S. government.

What changes the price buyers are willing to pay? Several factors can work together.

Inflation Changes What Future Payments Are Worth

Inflation reduces purchasing power. For investors receiving fixed payments over several years, inflation affects what those payments will be worth when they arrive.

If investors expect inflation to remain higher, they may require a higher yield to compensate. That can put downward pressure on existing Treasury prices. If inflation expectations ease, the reverse may happen.

The focus is on what comes next, not just today’s inflation reading. A report showing slower price increases may have little effect if investors already anticipated it. Information that changes their outlook can matter more than the headline numbers alone.

Markets Do Not Wait for the Fed

The Federal Reserve sets a target range for the federal funds rate, a short-term interest rate. It does not directly set the market yield on a 10-year Treasury note.

Treasury yields reflect, in part, expectations about where short-term rates will go. If investors begin to expect rates to stay higher for longer, yields may rise before the Fed makes another decision. Expectations for lower rates can push prices up resulting in lower yields.

This helps explain why a Fed announcement does not always produce an obvious market reaction. An anticipated decision may already be reflected in current prices. What officials say about future policy, or what investors anticipate that change in policy to be, can change expectations more than the decision itself.

Economic Reports Can Change the Outlook

Employment, consumer spending and business activity reports help investors assess the strength of the economy.

Stronger-than-expected growth may raise expectations that interest rates will remain elevated, potentially pushing yields higher. Weaker activity may increase expectations for future rates to be lower, which may contribute to higher demand for current Treasury securities and resulting in falling yields.

But economic reports rarely tell one simple story. Strong hiring could support expectations for company earnings while also raising concerns about inflation. A weaker report could ease those concerns while creating new questions about demand for current Treasuries.

The market’s response depends on what the report changes about the outlook and how that compares with what investors previously expected.

Supply and Demand Matter, Too

The Treasury issues securities to finance government borrowing, including replacing debt that comes due. Investors’ willingness to buy that debt helps determine the yields at which it can be sold.

If the amount available increases without a matching increase in demand, prices can face pressure and yields may rise. Stronger demand can increase prices and lower current yields.

This is one reason Treasury auctions attract attention. They provide information about demand at the prices and yields available at that time. However, one auction does not establish a lasting trend, and more borrowing does not automatically mean yields will rise. Other market forces may offset its effect.

Lending for Longer Brings More Uncertainty

Holding debt for ten or thirty years means facing uncertainty about inflation and interest rates well into the future.

Investors may require additional compensation for taking that longer-term risk. The amount they require may change, which can move longer-term yields even when expectations for the next Fed meeting barely shift.

As a result, short- and long-term Treasury yields do not always move together or by the same amount.

What the Move Means for Stocks

Higher yields can put pressure on stock valuations and borrowing costs. But rising yields alongside stronger growth may come with improving earnings expectations. Falling yields can ease financing pressures, yet they may also reflect concern about a slowing economy.

For stock-market participants, the useful question goes beyond whether yields moved up or down: What changed about expectations, and how might that affect businesses?

A Treasury yield is determined by several influences. Its direction alone cannot identify the cause of a move or predict what stocks will do next.

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