US Treasury yields are rising, but what does that mean for markets and crypto?

Across all tradable markets and currencies, US Treasuries – Treasuries – have significant leverage. In finance, any measurement of risk is relative, meaning that if one insures a house, the maximum liability is set in a form of money.

Similarly, if a loan is taken from a bank, the creditor must calculate the odds that the money will not be returned and the risk that the amount will be devalued by inflation.

In the worst case, let’s imagine what would happen to the costs associated with issuing debt if the US government temporarily suspended payments to certain regions or countries. Currently, there are over $7.6 trillion in bonds held by foreign entities, and several banks and governments depend on this cash flow.

The potential cascading effect from countries and financial institutions will immediately affect their ability to settle imports and exports, leading to further carnage in the lending markets as each participant will rush to reduce risk exposure.

There are over $24 trillion in U.S. Treasuries held by the public, so participants generally assume that the lowest risk that exists is a government-backed debt security.

Treasury yields are nominal, so watch out for inflation

The yield that is widely covered by the media is not what professional investors trade, because each bond has its own price. However, based on the duration of the contract, traders can calculate equivalent annual returns, making it easier for the general public to understand the benefit of holding bonds. For example, buying the US 10-year Treasury at 90 entices the owner with the equivalent of a 4% yield until the contract matures.

If the investor believes that inflation will not be kept down for the first time, the tendency is for the participants to demand a higher return when trading the 10-year bond. On the other hand, if other governments are at risk of becoming insolvent or hyperinflating their currencies, the chances are high that investors will seek refuge in US Treasuries.

A delicate balance allows US Treasuries to trade lower than competing assets and even run below expected inflation. Although unimaginable a few years ago, negative interest rates became quite common after central banks cut interest rates to zero to boost the economy in 2020 and 2021.

Investors pay for the privilege of having the security of government-backed bonds rather than facing the risk of bank deposits. As crazy as it may sound, over $2.5 trillion of negative yielding bonds still exist, which does not take into account the effect of inflation.

Regular bonds price higher than inflation

To understand how disconnected from reality the US Treasury bond has become, one must realize that the yield on the three-year note is 4.38%. Meanwhile, consumer inflation is at 8.3%, so either investors believe the Federal Reserve will succeed in easing the calculation, or they’re willing to lose purchasing power in exchange for the world’s lowest-risk asset.

In modern history, the United States has never defaulted on its debt. Simply put, the debt ceiling is a self-imposed limit. Thus, Congress determines how much debt the federal government can issue.

By comparison, a bond from HSBC Holdings due in August 2025 is trading at a yield of 5.90%. In essence, one should not interpret the US Treasury yields as a reliable indicator of inflation expectations. Moreover, the fact that it reached its highest level since 2008 is less important because data shows that investors are willing to sacrifice earnings for the safety of owning the lowest-risk asset.

Consequently, the US Treasury yields are a great instrument to measure against other countries and corporate debt, but not in absolute terms. These government bonds will reflect inflation expectations, but may also be severely constrained if the general risk to other issuers increases.