What’s the Deal with Treasury Yields?

First up, lemme give y’all the 411 on what the heck Treasury bonds are.

U.S. Treasury Bonds are financial instruments that are issued to the public by the U.S. Treasury Department whenever it needs more moolah.

This is basically how it works:

When you purchase these bonds, you are basically lending to the government. You are compensated with this “risk” in the form of interest payments. This is otherwise known as the Treasury Yield.

What normally happens is that when not too many people are buying bonds, yields tend to increase, in order to entice people to buy. On the flip side, when more and more people are buying bonds (usually when risk aversion is in play), yields tend to decrease.

Some market players see Treasury yields as an indicator of the strength of the U.S. stock market. Rising yields normally signify lower demand for low-yielding Treasury bonds and conversely, more demand for higher-yielding equities.

Treasury yields also have an effect on our beloved forex market. USD/JPY, in particular, tends to move in tandem with Treasury yields, rising when yields are higher and falling when they are lower.

Interestingly enough though, this doesn’t seem to be the case lately.

Yields have been on the rise the past couple of weeks, with that for 10-year Treasury bonds hitting a 2-year high at 2.89% last Monday. That marks the fifth time in the past 6 days that yields have surged higher! However, despite the rise in yields, we have yet to see a similar move on USD/JPY, as the pair has failed to rally above 98.00.

What the heck is causing all the commotion in the markets? My guess is that it’s because of “Septaper.”

Yields vs USD/JPY Chart

About a month after Fed Reserve head honcho Ben Bernanke announced that the bank could taper asset purchases in June, USD/JPY and bond yields began to diverge. It would seem that investors soon became worried about the consequences of the Fed‘s decision. Given that the outlook for the economy is still uncertain, investors have chosen to reduce their exposure to U.S. assets.

Now the question on everyone’s mind is, will the economy continue its path to recovery even when the Fed lessens its stimulus?

The consensus is for the Fed announce tapering in its next statement on September. However, if yields continue to rise and make it more expensive for the Fed to pay back its IOUs, we could hear the central bank downplay its excitement over taking a step back from asset purchases.

Some market junkies are particularly eyeing the 3.00% level. If yields are at that level or higher, the Fed to lessen the amount it tapers or it could hint that further reduction won’t come anytime soon. Heck, there are those who even say that Septaper may not happen at all!