The Relationship Between Treasury Yields & Intermediate Bond Funds
A yield on a bond is the interest rate it pays. Treasury yields on bonds are often considered a bellwether--an indicator of the direction of bond prices and bond yields will go. With bonds, price and yield are inversely related. When yields (the interest rate paid) go down for existing bonds, prices go up for new bonds with higher yields. This happens because investors are willing to pay the higher price to get a better yield.
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Declining Treasury Yields
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Treasury bond yields are at historic lows (as of September 2011). Though these bonds offer safety because they are backed by the United States government, their yields are low, especially compared to corporate bonds. This has caused prices to rise on bonds that pay more than treasuries. Intermediate bonds mature in three-and-a-half to six years. These funds benefit from a price rise because the portfolio of bonds that these funds hold rises in value.
When Treasury Yields Reverse
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If treasury yields start to climb again, investors might be attracted to the increasing yields. This means that other bond prices will go down, because the treasuries are siphoning off buyers with attractive yields. Intermediate bond funds, in this scenario, would experience a drop in prices of bonds. This would lower the value of the bond funds.
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Bond Funds with Extra Cash
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Intermediate bond funds that are not fully invested might be best positioned to take advantage of rising treasury bond yields. If yields start to rise, the fund can purchase bonds with higher yields and thus maintain income from the bonds to help make up for a drop in prices.
Income vs. Price Appreciation
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Many investors buy intermediate bond funds to get income. The income comes from the interest rate the bonds pay. Though the fund itself might go down in value, those interest payments will continue. Long-term bond investors might want to ignore price fluctuations of the fund.
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