10-Year Treasury Yields Under 2% – What to Do?

by Darwin on May 13, 2012

A quick look at the market shows something fascinating: stocks continue higher while the 10-year Treasury yield creeps back to below 2%. Last week, yields on the 10-year Treasury fell to 1.84%. We seem poised to return to 10-year yields consistent with yields during the worst of Greek debt crisis fears.

So what’s up with the 10-year?

10-Years’ Signals to Investors

The 10-year Treasury throws off a variety of signals to investors including:

    1. Implied inflation – If Treasuries are risk-free, a little conceptual algebra lets us know that the yield for any given US Treasury bond is pure inflation expectations.
    2. Risk-appetite – When investors go risk-off, Treasuries are the place to be. Think of it like an FDIC-insured bank for investors with too much capital to go open thousands of $250,000 savings accounts.
    3. Credit risk – The US dollar is still the most liquid currency in the world. When credit crises hit, they hit hard. While the US financial crisis and credit crunch hit the US, it hit non-reserve currency countries even harder. Keeping cash in dollars is a good way to make sure you can move it at a moment’s notice.

Investigating the 10-Year Yield Chart

The Chicago Board Options Exchange has a contract for the 10-year Treasury yield. You can look it up at Yahoo Finance under the ticker ^TNX.

Here’s a quick look:

10-year treasury yields

As you can see, the 10-Year Treasury yield is retesting lows last seen during the Greek debt crisis. Greece’s debt crisis is hardly over. In fact, I spot a few interesting correlations between recent events and the 10-year yield:

    1. March Peak – The March peak is consistent with a risk-on move to riskier assets, including stocks. The S&P500 rallied to year-to-date highs during the period.
    2. European bailout – American investors hardly noticed what was going on in Europe in March. During the period, the European Central Bank loaned 529.5 billion Euros (roughly $890 billion) to banking institutions on a 3-year maturity at 1% annual interest. Likely, these loans allowed banks to temporarily move cash out of US Treasuries and into riskier assets.
    3. Move back to safety – Following Greek elections of anti-austerity politicians and an election in France that gave an anti-finance socialist politician the French presidency, financiers around the world are worried Greece’s debt issues won’t be solved any time soon.

Low Rates: Use ‘Em or Lose ‘Em

For individuals, lower rates are a boon. As the US Treasury yield is the benchmark for risk-free lending, it is also the benchmark for mortgages, student loans, car loans, and other financing for consumers. Banks take the 10-year rate, slap a premium on top, and offer the rate to borrowers like us.

So how can we make the best possible use of low-rates and fears in Europe?

    1. Refinance – Seriously, if you’ve yet to refinance, you’re missing out on what might be the best rate you have ever seen in your life (table to current rates in your state). Mortgage rates share a perfect correlation with the 10-year US Treasury, which rarely yields less than 2% per year.
    2. Rebalance – Unless you’re nearing retirement, you have to start accepting more risk in your investments. The reality is that bonds are trading for very lofty premiums, while inflation threatens your total potential return. While no one wants to pay too much for stocks, no one wants to pay too much for bonds, locking in a guaranteed loss when one considers the rate of inflation going forward. Countless dividend-paying stocks yield more than the 10-year US treasury yield, and despite their own premium, dividend-paying equities still have the opportunity for capital appreciation if stock markets rise.
    3. Leverage? – Those who haven’t been keeping pace with their retirement contributions might want to consider leveraging with a cash-out refinance or a longer amortization schedule on their mortgage. Given the tax benefits of mortgage debt and a paltry 30-year fixed rate of 4% for mortgage loans, it might be high time to think about playing catch up with other people’s money.

Events like these don’t happen very often. Generally, bond yields should rise as stocks rally, but the current market is breaking from historical norms.

How do you plan to use low rates?

Have you rebalanced your retirement to reduce bond exposure to increase stock exposure?

Do you think low rates are sustainable for the long term?

{ 6 comments… read them below or add one }

AverageJoe May 15, 2012 at 8:49 pm

I’ve ignored treasuries in favor of high yield. The risk in the HY index isn’t much higher (I didn’t believe that fact at first, but then saw the stats….incredible) and returns are much higher. I’m with you, JT….yields are incredibly depressing, unless you’re a homeowner!


JT May 16, 2012 at 1:47 pm

You’re always rewarded disproportionately for taking on more risk, in my view. The real risk is playing it too safe. It’s easy to say that high yield indexes provide maybe 1-2% more in returns. But if inflation going forward is 1.5%, treasuries yield…say, 2%, and high yield indexes yield 4%, the difference isn’t just 200 basis points. The difference is the real rate of return, which is 5x higher in high-yield indexes than Treasuries (50bp vs. 250bps).



Financial Samurai May 16, 2012 at 2:09 am

JT, what to do? You’ve got to convince Darwin to stop being scared about inflation!


JT May 16, 2012 at 1:43 pm

We all have different inflation rates. As inflation is most visible in areas where government subsidies exist…say, college education, it makes sense for Darwin to worry about inflation as he has children.

You’re the guy that says it’s all about perspective, right? Anyone can say with certainty that college costs will continue to grow in excess of inflation, as it is tied directly to the source of inflation – government largess.


uclalien May 19, 2012 at 4:14 pm

A number of things worth pointing out:

1) All of your arguments in favor of the USPS assume that letters even need to be sent. The vast majority of anything my family mails is what I would consider “luxury mail.” In other words, there are at least 2 alternatives. But we choose to send physical mail because it’s “fun.” And given the rapid decrease in mail usage (despite a growing population), most people have already consciously or unconsciously come to the realization that physically mailing letters is an unnecessary expense. This trend will not reverse.

2) “Look at it this way: if 3.8 pieces of mail are delivered by USPS today, why would 1.9 pieces of mail delivered by Fedex and 1.9 delivered by UPS be cheaper?”

You’re missing the point. It wouldn’t be 1.9; it would probably be < 0.5. As it stands, USPS is effectively a way for taxpayers to subsidize their own efforts to pay more to communicate. Does that make any sense? Without the subsidy, most people would no longer feel the need to waste money mailing certain things. Put even another way, they would find alternatives.

Yes, some people may pay more to send mail, but the vast majority will not. As a whole, the population would spend far less.

3) If you look at USPS's financial statements, you will see that it has been receiving roughly $3,000,000,000 ($3 billion) per year from the federal government for as far back as I could find records. In other words, USPS is, and has been, heavily subsidized even in good years.

4) USPS is a social welfare program, plain and simple. As this blog post states, people who CHOOSE to live in the middle of nowhere are being heavily subsidized by people who choose not to. Why should a certain segment of the population carry the financial burden of someone else's choice? Alternatively, it could be argued that the people who live in the middle of nowhere (presumably with lower housing costs) should therefore subsidize the higher housing costs of a person who chooses to live in a city center. Doesn’t make much sense does it?


uclalien May 19, 2012 at 4:16 pm

Can you delete this post? I was in two of your blog postings simultaneously and posted it to the wrong one. Thanks.


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