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I understand that when investors’ confidence level is low, the demand for Treasuries will increase, hiking up Treasuries’ prices and lowering their yields. As a result, declining Treasury yields are typically viewed as indicating a potential economic slowdown. Right now, as of Aug 2022, GDP figures are indicating that the US may already be in a recession (according to some definitions).

So why aren’t US Treasury yields going down, since, in principle, investors should be buying more US Treasuries, not less.

For reference, see the chart: cnbc.com/quotes/US10Y

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Federal Reserve System is likely to raise interest rates because of inflation thus making money market rates (market where different banks and non-bank institutions lend each other money) higher. Higher interest rates in money market make financial institutions to sell bonds and allocate their money to money market or deposits in FRS.

When bonds are sold their price falls making coupon payments and maturity payment more attractive and raising yields because they are calculated as PV / price of bond.

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  • $\begingroup$ So it seems that everything I wrote is valid, except that the current inflation environment is the one element that changes things? $\endgroup$ Aug 7, 2022 at 19:52
  • $\begingroup$ Yes, knowadays yields of financial assets in US are closely related to expected path of federal reserve interes rate. Normaly in recession fed was going to cut rates, but in 2022 high inflation is more hard problem that temporary stagnation of GDP. $\endgroup$ Aug 7, 2022 at 20:03
  • $\begingroup$ How banks react to higher policy rates is not very clear and is only part of the story. For example, you say that banks reallocate from bonds to the money market (holding more cash) or deposit in FRS (holding less cash). Holding more cash seems counterintuitive when rates are rising. $\endgroup$
    – BrsG
    Aug 8, 2022 at 10:31
  • $\begingroup$ This is not a storyabout more or less cash because banks can sell bonds otc (not in the exchange). When one bank that held bond sell it to another bank price of stock drops, but these two banks still have same amount of cash. Secondly, banks reallocated to money market do not hold more cash, because they need cash in order to lend it and get liability of other institution that has yield that is slightly higher that lower edge of frs interest band. Thirdly, if there is no demand for cash in money market bank can go to deposit in frs that has frs interest rate return. $\endgroup$ Aug 8, 2022 at 22:11
  • $\begingroup$ Both interest rates in money market and interest for deposits in frs are connected to frs policy rate. These two interest rates after the positive shock of policy rate are higher than bond yield. This makes banks to sell bonds and go to money market or deposits in federal reserve. $\endgroup$ Aug 8, 2022 at 22:14

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