Understanding Treasury Notes
The Treasury Note Market and the Potential for Interest Rate Hikes
The absolute level of interest rates, which is directly under the control of a central bank, or the shape of the yield curve, is the most common place for a change in rates to take place.
Additionally, these fixed-income instruments have varying degrees of sensitivity to shifts in interest rates, which indicates that the decline in prices takes place at a range of different intensities.
An excellent illustration of an absolute change in interest rates occurred in December 2015, when the Federal Reserve (the Fed) raised the federal funds rate to a range that was 25 basis points higher. This is a good example of an absolute shift in interest rates. It had previously been in the range of 0% to 0.25% at that time, but after that, it was changed to being in the range of 0.25% to 0.50%. The impact of this increase in benchmark interest rates has been to bring about a decline in the prices of all outstanding notes and bonds issued by the United States Treasury.
Considering the Finer Points
Alterations in the yield curve, which are referred to as yield curve risk, are caused by factors in addition to the benchmark interest rate. These factors include changing investors’ expectations. This risk is connected to either a steepening or flattening of the yield curve, which is the result of a change in the yields among bonds of the same type but of different maturities.
For instance, in the event of a steepening curve, the spread between short-term and long-term interest rates widens as a result of an increase in long-term rates that is greater than the increase in short-term rates. In the event that short-term interest rates ended up being higher than any of the longer-term interest rates, a situation that is known as an inverted yield curve would result.
Because of this, the price of long-term notes goes down in comparison to the price of short-term notes. When the yield curve flattens out, the opposite of what was expected happens. The spread gets smaller, and the prices of short-term notes go down in comparison to the prices of long-term notes.