Short-Term Treasury Bonds Vs. Long-Term Treasury Bonds
The U.S. Department of the Treasury issues a wide range of bond securities. Terms at issue range from four weeks on the short end out to the 30-year Treasury bond. Short-term versus long-term Treasuries offer investors different opportunities and potential. The choice between the two ends of the Treasury spectrum is dependent upon investment goals and interest rate outlook.
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Types of Treasuries
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At the short end of the Treasury security spectrum are Treasury bills, known as T-bills. Treasury bills have terms of four to 52 weeks and are sold at a discount to the final face amount. The difference between the price and the face amount is the interest earned on the bill. In the intermediate range are Treasury notes with terms of two, three and five years. Long-term Treasury bonds are seven- and 10-year notes and the 30-year bond. Notes and bonds pay interest every 6 months to bond holders. The 10-year Treasury note is most often used as the index rate for long-term interest rates.
The Yield Curve
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The yield curve is a graphic portrayal of Treasury interest rates from short to long term. The most typical yield curve is with interest rates getting higher as the term gets longer. Occasionally, short-term rates are higher than long-term rates. This effect is called an inverted yield curve. In December 2010, the Treasury yield curve was normal and here are some of the rates along the curve:
Three-month rate: 0.16 percent
One-year rate: 0.28 percent
Two-year rate: 0.53 percent
Five-year rate: 1.64 percent
10-year rate: 2.97 percent
30-year rate: 4.24 percent
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What Determines Yields
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Yields for short-term Treasury securities are primarily determined by the actions of the Federal Reserve Board. The Fed sets the federal funds target rate and the discount rate. These rates control the rates banks can borrow money and the T-bill market follows the lead of the Federal Reserve. Long-term Treasury bond rates are determined by the market forces of supply and demand. Long-term Treasury rates are driven by the bond market expectation of future interest rates and inflation.
Rising or Falling Rates
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Bond prices adjust inversely to changes in interest rates. If rates increase, bond prices fall, and falling interest rates mean bond values increase. In a falling rate environment, investors want to buy long-term bonds to lock in higher rates and earn possible capital gains from price increases in the bonds. In a rising rate scenario, holding short-term Treasury securities allow the investor to receive the full principal amount at maturity and reinvest the proceeds at the new, higher rates.
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