The Federal Reserve and The Treasury Department: What's The Difference?
The Federal Reserve is a national banking system that oversees the general function of the United States economy. Its primary duties are to oversee and regulate the nation's banks and to enforce fair credit practices. It serves a major role in regulating the economic stability and minimizing economic risk. It also manages the nation's currency supply.
The Treasury Department, on the other hand, is a separate department that manages federal spending, collects taxes, and issues currency and bonds. It can also print new money when needed and enforces current economic policies. The Federal Reserve is responsible for paying interest rates. Both groups work together to sustain the economy and to borrow money to pay the nation's bills.
Treasury yields are important indicators of financial outcomes. They offer a view of what might happen with markets. The best definition of how treasury yields work requires a closer look at their rates and how they correlate to the current state of the market.
How Maturity Occurs With Treasury Bonds
10-year treasury bonds are reputed for being stable and trustworthy. Anything that matures slowly and steadily over time is considered a good investment for anyone.
Interest on 10-year treasury bonds accrues every six months at a fixed rate. It builds over time and allows the bond to mature slowly over a length of time. It reaches full maturity after 10 years and can be cashed in.
2-year bonds, on the other hand, may be easier to invest in and have shorter terms. But the drawback is that they aren't long-term and may not reach the same level of maturity as a 10-year investment. In either case, both bond types are considered low-risk because they are an investment in the government rather than a more volatile private sector.
What Are Treasury Yields?
People who purchase treasury bonds are essentially investing in the government. A bond is a loan that the government can use to pay some of its bills. In exchange for that loan, the government has an obligation to pay it back in the form of interest. These rates are also known as treasury yields.
These yields are then expressed as percentages, which are the rates in which the investment matures. This happens slowly over time and with penalties for early withdrawal. Differences in rates between a long-term and a short-term investment is known as a yield spread.
What is a Yield Spread is Calculated
Calculating a yield spread is simple. It is the difference between a long-term and a short-term investment. For example, if a 2-year bond has a yield of $2 while a 10-year bond has $4, then the difference is $2. In any case, the yield spread serves as a warning that a recession may be coming.
The 10 - 2 Spread
A yield curve offers a summary of how the market is doing and a glimpse into what may happen. When the curve grows, investors know that they can expect higher interest rates, inflation, and more growth. At this point, the treasury yield is stating that the economy is in good shape, and that means investors can cash in now for a higher payment.
However, there are times when that same curve can flatten. This means that growth will be slow as interest rates decrease. Lower rates of inflation will flatten the curve further, which indicates that the market could be heading towards a recession.
The best way to foresee this is by analyzing the 10 - 2 spread, which signifies the difference between two different treasury notes: the 10-year and the 2-year.
There are times when the difference is a negative number. This happens when the yield on a 2-year investment is greater than a 10-year one. This is often a red flag of a possible recession.
The 10 - 2 Spread And The Inverted Yield
A 10 - 2 spread gives a summary of the the economy. When the yield on a 10-year note is greater than that of a 2-year, the market is going strong. However, this can change. The curve can drop towards zero and flatten. Once it hits the line below zero, the yield of a 2-year note is greater than the 10-year. This is known as an inverted yield.
Inverted Yields
When long-term rates are less than short-term rates, they indicate a decline in the bond's long-term value. Known as inverted yields, these are rare occurrences but can happen anyway. Anytime short-term rates are higher than long-term ones, this indicates that there is trouble within the market.
The general behavior of a yield is a reflection of the current market status. A normal yield is an indicator of a stable and healthy market. Inverted yields, on the other hand, are good predictors of an impending recession. They can help investors gauge for themselves if the treasury bond is worth investing in at the time of purchase.
What Does This Really Mean?
Inverted yields are only indicators of a potential recession and should not be construed as fact. When the curve goes towards zero with the threat of dipping below, its no call for investors or the public to panic. It's like approaching a yield sign in traffic. It only means to stop if necessary and proceed with caution.
There are other potential factors involved when trying to pinpoint the future of the economy. One is inflation, another is rising wages. Growth in the public and private sectors should be noted as well. If more jobs are being created, this might mean that the economy can only get stronger. Additional clues such as consumer confidence and spending can offer a bigger picture of an economy's future as well.
https://www.federalreserve.gov/aboutthefed/the-fed-explained.htm#:~:text=The%20Federal%20Reserve%20monitors%20financial,households%2C%20communities%2C%20and%20businesses.
https://www.investopedia.com/terms/t/treasury-yield.asp
https://www.wealthvest.com/wealthvestblog/the-2-and-10-year-treasury-spread-why-this-is-an-important-economic-indicator
