Understanding U.S. Treasury Yields: A Practical Guide for Beginners

Currently, in the uncertain economic environment, many investors are seeking assets that can simultaneously ensure profitability and stability. U.S. Treasury yields serve as a benchmark for global financial markets and are especially valued by Korean investors as a key means of diversification. U.S. Treasuries, characterized by low risk and high liquidity, can be central to conservative asset allocation strategies. This article explores the meaning of U.S. Treasury yields, specific purchasing methods, and strategic approaches available to Korean investors.

Basic Concepts of Bond Investment

Bonds are essentially promises to repay borrowed money. When an investor provides funds to a debtor(government or corporation), the debtor agrees to return the principal at a set maturity date and pay periodic interest. Typically, interest is paid semiannually or annually.

Government-issued Treasury bonds are a means to raise funds necessary for national operations. When tax revenues are insufficient, the government issues bonds to borrow from institutions and individual investors, offering regular interest payments in return.

The most actively traded maturity in the bond market is the 10-year Treasury. It is mainly traded for investment purposes in the secondary market and is used as a key indicator reflecting the global economic situation.

Relationship Between U.S. Treasury Yields and Returns

Types of U.S. Treasury Securities

U.S. Treasury securities issued by the U.S. Department of the Treasury are classified into three types based on maturity:

T-bill( Short-term Treasury): Maturities under 1 year, virtually risk-free with very high liquidity. Suitable for short-term cash management.

T-note( Medium-term Treasury): Maturities from 1 to 10 years, suitable for investors seeking medium-term returns.

T-Bond( Long-term Treasury): Maturities from 10 to 30 years, with fixed interest rates. A primary choice for investors aiming for long-term asset preservation.

Meaning of U.S. Treasury Yields

U.S. Treasury yields serve as more than just returns; they act as benchmarks in the global financial market. Many financial institutions use them as a reference for risk-free rates, with the 10-year Treasury yield being recognized as an indicator of the macroeconomic health of the world economy.

Bond yield( refers to the expected return relative to the bond’s purchase price. Since market prices fluctuate in real-time, U.S. Treasury yields also vary according to market supply and demand conditions.

) Price and Yield Inverse Relationship

Bond prices and U.S. Treasury yields move in opposite directions. When demand for safe assets increases, bond prices rise and yields fall. Conversely, when demand decreases, prices fall and yields rise. Therefore, changes in yields can signal investor sentiment and market outlook.

In deteriorating economic conditions, demand for long-term bonds tends to increase regardless of yield levels. This phenomenon can lead to an inverted yield curve, which is often interpreted as a recession indicator.

Four Key Benefits of Investing in U.S. Treasuries

1. Highest Safety

U.S. Treasuries backed by the full faith and credit of the U.S. government are regarded as the safest assets in financial markets. During economic crises, many investors flock to U.S. Treasuries, which are considered virtually free of default risk. This exemplifies the global trust in U.S. Treasury security.

( 2. Fixed Income Structure

U.S. Treasuries have fixed interest rates established at issuance, with interest typically paid regularly every six months. This predictable cash flow makes them ideal for retirees or conservative investors seeking stable income.

) 3. Excellent Liquidity

U.S. Treasuries are among the most actively traded securities in the bond market. Investors can hold them to maturity or sell them at any time when funds are needed, facilitating portfolio adjustments. This high liquidity is a crucial element of diversification strategies.

4. Tax Benefits

Interest income from U.S. Treasuries is subject to federal income tax but exempt from state and local taxes. As a result, the after-tax yield can be higher than the nominal rate when considering tax effects.

Four Risks to Consider When Investing in U.S. Treasuries

1. Interest Rate Risk

When U.S. Treasury yields rise, new bonds are issued at higher rates, causing the market value of existing bonds with lower rates to decline. Selling bonds before maturity in such a scenario can lead to losses. This risk is more pronounced for long-term bonds.

2. Inflation Risk

Fixed-rate U.S. Treasuries may not keep pace with rising inflation, reducing real purchasing power if inflation exceeds the yield. Treasury Inflation-Protected Securities (TIPS) offer a hedge against this risk, but standard Treasuries do not.

3. Currency Risk

For foreign investors, exchange rate fluctuations are a significant risk. If the US dollar weakens, the value of interest and principal in Korean won decreases when converted back, impacting returns. This is a key consideration for Korean investors.

( 4. Credit Risk

While the possibility of the U.S. government defaulting exists in theory, the U.S. has historically been regarded as the most reliable issuer of debt. Therefore, the actual credit risk is considered very low.

Three Ways to Purchase U.S. Treasuries

Investors can choose among different methods based on their goals, risk appetite, and preferences.

) 1. Direct Purchase

Buying Individual Bonds

Investors can purchase U.S. Treasuries directly from the government via the TreasuryDirect website###, or through securities firms in the secondary market.

Advantages: Direct ownership provides control over the bonds. Unlike mutual funds or ETFs, there are no management fees. Holding to maturity ensures receipt of periodic interest and full principal.

Disadvantages: Purchase limits are capped at $10,000 per individual. Diversification requires significant capital to buy multiple bonds. Selling before maturity during rising interest rates can incur losses.

Suitable for: Retirees seeking stable income with long-term holding, investors managing their portfolios directly, and conservative investors needing predictable cash flows.

2. Bond Funds

Operational Model

Pooling funds from multiple investors, professional fund managers create and manage diversified bond portfolios.

Advantages: Diversification across various bonds reduces individual bond risk. Active management adjusts portfolios according to market conditions. Small investments enable access to multiple bonds.

Disadvantages: Management fees reduce overall returns. Investors have no direct control over individual bonds.

Suitable for: Investors seeking professional management and diversification, those avoiding the hassle of managing individual bonds, and risk-averse investors aiming for stable long-term returns.

( 3. Bond Index Funds)ETF###

Operational Model

Passive funds tracking specific bond indices, e.g., U.S. Treasury indices, traded on stock exchanges like stocks.

Advantages: Low management fees due to passive operation. High liquidity and trading flexibility. Transparent operations.

Disadvantages: Subject to stock market volatility, leading to price fluctuations. Tracking errors may occur due to management fees and trading costs. No active management for additional alpha.

Suitable for: Investors seeking low-cost passive exposure, those preferring direct investment, and believers in market efficiency.

Strategic Asset Allocation for Korean Investors

Combining Korean and U.S. Treasuries can enhance portfolio diversification.

Benefits of Multi-Currency Diversification

Reducing Regional Risks

Distributing investments across two markets mitigates risks from economic downturns, political instability, or interest rate changes in a single country.

Currency Hedging Opportunities

Holding both KRW-denominated and USD-denominated bonds can naturally offset currency risk. When the won weakens, the value of U.S. Treasuries in won terms rises; when the won strengthens, Korean bonds may outperform.

Exploiting Economic Cycle Divergence

Korea and the U.S. do not always move in sync economically. A slowdown in one can be offset by growth in the other, smoothing overall portfolio performance.

Yield Optimization Strategies

Investors can analyze the yield curves of both countries’ bonds to maximize returns. For example, if Korean bonds offer higher yields at the same maturity, maintaining a core position in U.S. Treasuries for stability while increasing Korean bond holdings can enhance yields.

Widening interest rate differentials create arbitrage opportunities—borrowing in lower-rate currencies and investing in higher-rate ones to profit from the spread.

( Key Considerations for Korean Investors

Managing Currency Risk

Hedging part of U.S. Treasury investments with forward contracts or options can lock in exchange rates, balancing currency risk and potential gains from favorable movements.

Optimizing Maturity Structure

Duration) of bonds indicates sensitivity to interest rate changes. For capital preservation, longer-maturity U.S. Treasuries can be used; for minimizing interest rate risk, shorter maturities are preferable.

Tax Planning

Interest from U.S. Treasuries is subject to U.S. federal tax but is exempt from Korean income tax under the Korea-U.S. Double Taxation Agreement###DTA###. Consulting tax professionals helps develop optimal tax strategies.

( Portfolio Construction Example

A balanced portfolio with 50% Korean bonds and 50% U.S. Treasuries can be considered. This aims to achieve principal preservation and income generation.

Adjusting the allocation by hedging 50% of the U.S. Treasuries against currency risk and leaving 50% exposed can generate additional returns during dollar strength, while hedged portions offset losses during dollar weakness.

Conclusion

U.S. Treasuries offer stable and reliable investment opportunities for both individual and institutional investors. To succeed, investors must understand the mechanisms behind yield fluctuations, inflation risks, and currency risks.

For Korean investors, strategic blending of U.S. and Korean bonds can achieve diversification, currency risk management, and yield optimization. Various purchase methods—direct purchase, funds, ETFs—allow investors to select the approach aligned with their goals and risk profiles, which is key to successful investment.