Treasury Yield Curve

TREASURY YIELD CURVE: Current Spot and Forward Curves

f you want to borrow money, you can go to a financial institution such as a bank. If you satisfy the bank that you have the ability to repay the loan, plus interest, it will lend you the money. This creates a fixed-income security, which is a contract specifying the timing and amounts of cash flows over time.

There are many types of fixed-income securities and markets. The largest fixed income market results from the U.S. Treasury, borrowing cash from the general investing public. The prices of these fixed-income securities result from trading, and which generates the Treasury yield curve by plotting the implied yield to maturity from the prices of Treasury instruments against the time to maturity. This yield curve has a direct influence over all economic activity in the US.

In the charts below the current behavior for the Treasury yield curve is provided for a choice of common compounding conventions. It also includes the current bootsrapped zero curve and implied forward rate curve. A complete expalnation of these concepts is provided in the Textbook link.

What Drives the Yield Curve?

From the above charts you can see that the yield curve shifts over time. These shifts are inresponse to changes in expectations about the major fundamental drivers of the yield curve. That is,

Inflation Expectations

Consumption/Growth Behavior Changes

Federal Reserve Bank Expectations

Inflation Expectations

If consumer prices are expected to increase strongly then the suppliers of capital must be rewarded more for postponing their consumption decisions. That is, the opportunity cost of consumption must increase and so inflation expectations will have a direct first order impact upon interest rates. To explore this further see the tab above labelled "Inflation."

Consumption/Growth Expectations

If growth declines and the economy moves into a recession -- how would this influence your decision to consume today? The answer is likely to be negatively. Job prospects, bonuses, pay rises are likely to disappear and so major consumption decisions become postponed. This implies that the suppliers of capital no longer need to be rewarded as much for postponing consumption and thus interest rates will decline.

Federal Reserve Bank Expectations

In the United States, the Federal Reserve has a dual mandate: To promote stable inflation and to promote maximum employment. In addition, the Federal Reserve is legally permitted to manipulate the US Treasury markets. As a result, the Federal Reserve Bank manipulates the US Treasury yield curve -- particularly at the short end in an attempt to implement it's dual manadate.

When the Federal Reserve Bank is trying to promote consumption and growth it lowers interest rates by agressively buying and pushing prices up. Given the inverse relationship between prices and the yield to maturity this implies that interest rates fall. If it is trying to dampen consumption/growth the Federal Reserve Bank does the opposite and starts to aggresively sell Treasury instruments to push prices down. This results in shifting interest rates up.