A recent article in Businessweek reports that treasuries are off to worst start since 2003 as the economy is expected to be recovering (Eddings and Austen). The article states the yield on benchmark 10-year notes have climbed 16 basis points or 0.16 percent. The rise in yield means the demand for the treasury notes has declined because the price and the yield of the bonds have an inverse relationship. The declining demand for treasury notes led to a decrease in their price which had the adverse effect of a rise in yield.
Bonds such as treasury notes are safer than other investment vehicles such as equities because they are backed by the U.S. government. This lower risk is the reason why they yields are almost always lower on U.S. government bonds than the equities of the corporations. When times are tough and the economic outlook is pessimistic, investors usually flock to the bonds in search of safety and away from the equities to lower this risk. This results in higher prices for the bonds as well as lower yields. But as the article points out, the U.S., economic outlook has been improving and unemployment claims has declined as well as housing sales are rising, the investors are once again comfortable taking more risks in search of higher returns. The result is their departure from the safer U.S. government bonds to equities in search of higher returns.
The article also mentions that while U.S. government securities have lost 0.342 percent this year, German bunds have declined by 0.1 percent during the same period. There are two possibilities why the U.S. government securities have declined by a greater margin. One reason may be that the U.S. economic outlook is brighter than German economic outlook. The second reason may be that U.S. was affected more by the recent recession than Germany, thus, its recovery may be supported by higher growth rate than Germany which might have weathered the recession relatively better.
But the trend has not been the same across all categories of bonds. Treasury Inflation Protected Securities (TIPS) have recently been sold at negative yields for the first time. This shows that the demand for TIPS is stronger because investors expect inflation to increase also along with the economic growth. Inflation eats into the returns earned by investors but TIPS take the inflation into account and, thus, are more attractive options when inflation levels are expected to rise in the future. The TIPS were sold at a negative yield of 0.046 percent instead of the expected 0.027 percent which probably also indicates that the investors expect the future inflation rate to be higher than the Fed’s expectations.
This article demonstrates that finance and economics have quite a close working relationship and a careful study of the financial markets and investment instruments gives important clues into the current trends as well as the future economic expectations. Thus, the activity in the financial markets is not only affected by the existing economic trends but also the investors’ expectations of the emerging economic trends. In addition, the financial markets do not only respond to local economic events but also international economic events, too as some of the rise in confidence in the U.S. is also due to progress in European crisis.
Eddings, Cordell and Sherman Austen. Treasuries Off to Worst Start Since 2003 as Economy Recovers. 21 January 2012. 21 January 2012 <http://www.businessweek.com/news/2012-01-21/treasuries-off-to-worst-start-since-2003-as-economy-recovers.html>.