Which economic factors impact Treasury yields?

Treasury yields are basically the rate investors are charging the U.S. Treasury for borrowing money. These rates vary over different durations, forming the yield curve. There are a number of economic factors that impact Treasury yields, such as interest rates, inflation and economic growth. All of these factors tend to influence each other as well.

1. Interest Rates

Treasury yields are a source of investor concern all over the globe. Treasury yields are the primary benchmark from which all rates are derived. Treasury notes are considered the safest asset in the world, given the depth and resources of the U.S. government.

When the Federal Reserve lowers its key interest rate, the federal funds rate, it creates additional demand for Treasuries, since they can lock in money at a specific interest rate. This additional demand for Treasuries leads to lower interest rates.

2. Inflation

When inflationary pressures emerge, Treasury yields move higher as fixed-income products become less desirable. Additionally, inflationary pressures typically force central banks to raise interest rates to shrink the money supply. In inflationary environments, investors are forced to reach for greater yield to compensate for diminished purchasing power in the future.

3. Economic Growth

Strong economic growth typically leads to increased aggregate demand, which results in increased inflation if it persists over time. During strong growth periods, there is competition for capital. As a result, investors have a plethora of options to generate high returns.

In turn, Treasury yields must rise for Treasuries to find equilibrium between supply and demand. For example, if the economy is growing at five percent and stocks are yielding seven percent, few will buy Treasuries unless they are yielding more than stocks.