<p>In general a longer maturity rate is practically speaking as equally profitable as a series of short maturity rates compounded. So for example, investing for 1 year thrice is as equally profitable as investing for 3 years. Investing for 6 months 16 times is as equally profitable as investing for 8 years. There is no certainty of equality and you can make money if you guess correctly. If there are many guessers then near equality will be realized. </p>

<p>The U.S. Treasury short maturity yield is higher than some of the long maturity yields (today), not because the short maturity investments are riskier. It is because the <a href="https://en.wikipedia.org/wiki/Federal_funds_rate" rel="nofollow noreferrer">very short term rate</a> (overnight) set by the Federal Reserve is high enough that the 3 month rate is higher than the 10 year rate. In other words, the expected mean rate for the next 3 months is higher than the expected mean for the next 10 years. Sometime in the future there might be a recession and the Federal Reserve might want to lower the overnight rate to help the economy. Sometime in the future the Federal Reserve might increase the overnight rate to reduce inflation. Both these considerations form expectations. </p>

<p>In addition to overnight rate setting, the Federal Reserve has engaged in other activity that influences Treasury rates. The Federal Reserve increased its holdings of Treasury bonds in the period from 2008 to 2014. <a href="https://www.ijcb.org/journal/ijcb11q1a1.pdf" rel="nofollow noreferrer">These economists (Gagnon and others)</a> in a paper titled "The Financial Market Effects of the Federal Reserve’s Large-Scale Asset Purchases" estimated that these purchases have been a downward force on long term rates. </p>

<p>The graph shows that those holdings have been decreasing since early 2018 so there might be reason to think that any downward force on long term rates is now not what it used to be so if we see a rise in those rates there is reason to think of causes that are apart from a change in risk perceptions.</p>

<p><a href="https://i.sstatic.net/xlAwA.png" rel="nofollow noreferrer"><img src="https://i.sstatic.net/xlAwA.png" alt="Treasuries at the Fed"></a></p>

<p>Addendum: @Michael rightly points out that market participants bidding up long term bond prices is another force that lowers long term bond yields.</p>

CC BY-SA 4.0
2019-08-18T23:43:53.500Z
I thought that the past trend toward decreasing long term yield had something with investor confidence in the market?
Jacob Woessner
CC BY-SA 4.0
2019-08-22T06:08:20.137Z
The U.S. Treasury 30 year bond rate has decreased since the early 1980's because the mean of expectations (for the next 30 years at each point in time) has decreased. After the high inflation 1970's the Fed tamed inflation with a temporarily high overnight rate. When expected inflation became lower, a very high overnight rate was no longer the policy.
H2ONaCl
CC BY-SA 4.0
2019-08-25T01:10:47.243Z
The above overstates the effect of the fed funds rate vis a vis yield curve inversion and omit the role of financial market. It's misleading. The fed funds rate/short rate only affects the short end of the curve. The Fed changes the short rate at 0.25% increments. That's not enough to invert the yield curve. The yield curve inverts mostly because of the movement in the long end---30yr TBill yield drops due to increased demand for risk-free asset by investors expecting an economic downturn.
Michael
CC BY-SA 4.0
2019-08-25T01:13:00.560Z
Also, regarding the cited paper "The Financial Market Effects of the Federal Reserve’s Large-Scale Asset Purchases", the Fed engages in QE ex post. Yield curve inversion is due to market's ex ante expectation.
Michael
CC BY-SA 4.0
2019-08-25T19:57:27.693Z
@Michael I did not omit the role of the market. The guessers I wrote about are arbitragers. Arbitragers are market participants. The Fed funds rate does not only affect short term rates and I explained how and it actually is enough to invert (but as you point out, not necessarily the only cause). Short term rates that are too high increases the likelihood of future recessions and a lower mean of the future path.
H2ONaCl
CC BY-SA 4.0
2019-08-25T21:01:25.633Z
continued... The mean is a good guess at the long rate. That's an example of the Fed funds rate causing inversion.  I did not mention market forces on the long term rates because the questioner seems to already understand that influence but I will make an addendum.
H2ONaCl
CC BY-SA 4.0
2019-08-25T21:11:05.170Z
@Michael If you don't think the Fed funds rate can cause inversion you should research what the Fed funds rate was in June 1981.
H2ONaCl
CC BY-SA 4.0
2019-08-25T23:04:24.910Z
So your claim is that market expectation about *future* fed funds rate affecting the yield curve means causal effect of fed funds on yield curve inversion? That's a funny definition of causality, to say some possible future event that may or may not occur causes what's happening today. Market belief about the short rate and the short rate itself are not the same thing.
Michael
CC BY-SA 4.0
2019-08-25T23:21:06.693Z
What's the arbitrage opportunity you're implying that causes YC inversion? Arbitrage means taking a long position on the cheaper asset. If I expect future short rates to be low, then long maturity bonds are more expensive, according to my expectation. Why would I then take a long position on long maturity bonds?
Michael
CC BY-SA 4.0
2019-08-25T23:25:07.650Z
What is happening is investors shifting from more risky assets, not interest rate arbitrage, but risk arbitrage.
Michael
CC BY-SA 4.0
2019-08-26T07:38:03.257Z
@Michael Today's yields depend upon expectations. That's not controversial at all. I did not say an arb opportunity causes inversion. I said arb activity nearly equalizes expectations of the ST yield and the actual LT yield today. In this context the curve might be inverted (falling) or flat or steep (rising). Regarding arbitrage: May be you will want to Google how to arb the 2 year versus the series of investments that is the 1 year today followed by a reinvestment in the 1 year a year from today. If you know how to do that, then you will better understand what I wrote.
H2ONaCl
CC BY-SA 4.0
2019-08-27T01:02:10.937Z
My question though is why would the curve invert for government bonds if government bonds are virtually risk free and there is no worry that the treasury will default on the bond? Or does it have something to do with interest rates in the short run that cause it to invert?
Jacob Woessner
CC BY-SA 4.0
2019-08-28T02:28:53.703Z
Please read the second paragraph of my answer.
H2ONaCl
CC BY-SA 4.0
2020-02-26T17:46:13.607Z
@JacobWoessner the inversion could also indicate that prices on the short end are falling more than on the long end; per yields being inversely defined against prices.
Queue Mann
CC BY-SA 4.0
2019-08-18T23:30:24.707Z
2019-08-25T19:50:31.543Z
2019-08-25T19:50:31.543Z
H2ONaCl
<p>There is another answer by H20NaCl that largely covers this question. I just wanted to add extra material.</p>
<p>One standard way of looking at observed nominal rates for bonds that are deemed to be free of credit risk is to split the nominal into two parts: an expected rate, plus a term premium. The expected rate is equal to the compounded short-term rate over the lifetime of the bond.</p>
<p>Although there is a consensus that this description makes sense, there is disagreement on how to decompose rates. The following link takes you to a page at the New York Fed that describes one method, and also has background material: <a href="https://www.newyorkfed.org/research/data_indicators/term_premia" rel="nofollow noreferrer">New York Fed term premia page.</a></p>
<p>As for the question, the inversion just implies that the expected path of rates was headed lower - which is exactly what happened from the time of the question. Normally, term premia increase with the bond maturity, but this was not enough to prevent the inversion. This matches the description in other answer. There was a debate in the comments about other factors influencing bond yields, but those are normally framed as affecting the term premium.</p>

CC BY-SA 4.0
2020-10-23T14:53:01.710Z
2020-10-23T14:53:01.710Z
Brian Romanchuk
<p>I have always thought that US securities were considered nearly risk free as the government will almost always pay them back. So why is it the case that investors currently view short term securities as more risky than long term ones?</p>

CC BY-SA 4.0
2019-08-25T11:03:17.557Z
It's not a question of risk. As you imply, the yield curve is viewed by the market as bench mark of term structure of risk-free returns.
Michael
<government-debt><bonds><usa>
Why does the inverted yield curve occur with US Treasury securities?
Jacob Woessner
# Why does the inverted yield curve occur with US Treasury securities?

(Asked by: username_0 on 2019-08-18)

I have always thought that US securities were considered nearly risk free as the government will almost always pay them back. So why is it the case that investors currently view short term securities as more risky than long term ones?

**Tags:** government-debt, bonds, usa

> **Comments:**
> **username_1**: It's not a question of risk. As you imply, the yield curve is viewed by the market as bench mark of term structure of risk-free returns.  

---

## 2 answers

### Answer by username_2 on 2019-08-18. Score: 2

In general a longer maturity rate is practically speaking as equally profitable as a series of short maturity rates compounded. So for example, investing for 1 year thrice is as equally profitable as investing for 3 years. Investing for 6 months 16 times is as equally profitable as investing for 8 years. There is no certainty of equality and you can make money if you guess correctly. If there are many guessers then near equality will be realized.

The U.S. Treasury short maturity yield is higher than some of the long maturity yields (today), not because the short maturity investments are riskier. It is because the [very short term rate](https://en.wikipedia.org/wiki/Federal_funds_rate) (overnight) set by the Federal Reserve is high enough that the 3 month rate is higher than the 10 year rate. In other words, the expected mean rate for the next 3 months is higher than the expected mean for the next 10 years. Sometime in the future there might be a recession and the Federal Reserve might want to lower the overnight rate to help the economy. Sometime in the future the Federal Reserve might increase the overnight rate to reduce inflation. Both these considerations form expectations.

In addition to overnight rate setting, the Federal Reserve has engaged in other activity that influences Treasury rates. The Federal Reserve increased its holdings of Treasury bonds in the period from 2008 to 2014. [These economists (Gagnon and others)](https://www.ijcb.org/journal/ijcb11q1a1.pdf) in a paper titled "The Financial Market Effects of the Federal Reserve’s Large-Scale Asset Purchases" estimated that these purchases have been a downward force on long term rates.

The graph shows that those holdings have been decreasing since early 2018 so there might be reason to think that any downward force on long term rates is now not what it used to be so if we see a rise in those rates there is reason to think of causes that are apart from a change in risk perceptions.

[![Treasuries at the Fed](https://i.sstatic.net/xlAwA.png)](https://i.sstatic.net/xlAwA.png)

Addendum: @username_1 rightly points out that market participants bidding up long term bond prices is another force that lowers long term bond yields.

> **Comments:**
> **username_0**: I thought that the past trend toward decreasing long term yield had something with investor confidence in the market?  
> **username_2**: The U.S. Treasury 30 year bond rate has decreased since the early 1980's because the mean of expectations (for the next 30 years at each point in time) has decreased. After the high inflation 1970's the Fed tamed inflation with a temporarily high overnight rate. When expected inflation became lower, a very high overnight rate was no longer the policy.  
> **username_1**: The above overstates the effect of the fed funds rate vis a vis yield curve inversion and omit the role of financial market. It's misleading. The fed funds rate/short rate only affects the short end of the curve. The Fed changes the short rate at 0.25% increments. That's not enough to invert the yield curve. The yield curve inverts mostly because of the movement in the long end---30yr TBill yield drops due to increased demand for risk-free asset by investors expecting an economic downturn.  
> **username_1**: Also, regarding the cited paper "The Financial Market Effects of the Federal Reserve’s Large-Scale Asset Purchases", the Fed engages in QE ex post. Yield curve inversion is due to market's ex ante expectation.  
> **username_2**: @username_1 I did not omit the role of the market. The guessers I wrote about are arbitragers. Arbitragers are market participants. The Fed funds rate does not only affect short term rates and I explained how and it actually is enough to invert (but as you point out, not necessarily the only cause). Short term rates that are too high increases the likelihood of future recessions and a lower mean of the future path.  
> **username_2**: continued... The mean is a good guess at the long rate. That's an example of the Fed funds rate causing inversion.  I did not mention market forces on the long term rates because the questioner seems to already understand that influence but I will make an addendum.  
> **username_2**: @username_1 If you don't think the Fed funds rate can cause inversion you should research what the Fed funds rate was in June 1981.  
> **username_1**: So your claim is that market expectation about *future* fed funds rate affecting the yield curve means causal effect of fed funds on yield curve inversion? That's a funny definition of causality, to say some possible future event that may or may not occur causes what's happening today. Market belief about the short rate and the short rate itself are not the same thing.  
> **username_1**: What's the arbitrage opportunity you're implying that causes YC inversion? Arbitrage means taking a long position on the cheaper asset. If I expect future short rates to be low, then long maturity bonds are more expensive, according to my expectation. Why would I then take a long position on long maturity bonds?  
> **username_1**: What is happening is investors shifting from more risky assets, not interest rate arbitrage, but risk arbitrage.  
> **username_2**: @username_1 Today's yields depend upon expectations. That's not controversial at all. I did not say an arb opportunity causes inversion. I said arb activity nearly equalizes expectations of the ST yield and the actual LT yield today. In this context the curve might be inverted (falling) or flat or steep (rising). Regarding arbitrage: May be you will want to Google how to arb the 2 year versus the series of investments that is the 1 year today followed by a reinvestment in the 1 year a year from today. If you know how to do that, then you will better understand what I wrote.  
> **username_0**: My question though is why would the curve invert for government bonds if government bonds are virtually risk free and there is no worry that the treasury will default on the bond? Or does it have something to do with interest rates in the short run that cause it to invert?  
> **username_2**: Please read the second paragraph of my answer.  
> **username_3**: @username_0 the inversion could also indicate that prices on the short end are falling more than on the long end; per yields being inversely defined against prices.  

---

### Answer by username_4 on 2020-10-23. Score: 0

There is another answer by H20NaCl that largely covers this question. I just wanted to add extra material.

One standard way of looking at observed nominal rates for bonds that are deemed to be free of credit risk is to split the nominal into two parts: an expected rate, plus a term premium. The expected rate is equal to the compounded short-term rate over the lifetime of the bond.

Although there is a consensus that this description makes sense, there is disagreement on how to decompose rates. The following link takes you to a page at the New York Fed that describes one method, and also has background material: [New York Fed term premia page.](https://www.newyorkfed.org/research/data_indicators/term_premia)

As for the question, the inversion just implies that the expected path of rates was headed lower - which is exactly what happened from the time of the question. Normally, term premia increase with the bond maturity, but this was not enough to prevent the inversion. This matches the description in other answer. There was a debate in the comments about other factors influencing bond yields, but those are normally framed as affecting the term premium.


---

