What is a UST and why it’s important?
The United States is the world’s largest economy and its’ capital market the biggest, making up almost 40% of global government and corporate debt (chart below). The US Treasuries (debt issued by the US government to finance all its activity), are a bedrock of the market.
There are USD28 trillion USTs outstanding and around USD910 billion trades daily (Source: SIFMA Research). Of these the 10-year UST is one of the most liquid and actively traded, which sees it act as the global benchmark for the risk-free rate. Lenders use it to determine how much to charge borrowers (i.e. customer margin) based on the risks of a particular loan.
A barometer for the global economy
The 10Y UST is more than just a benchmark, it’s also a signal of where the global economy is heading.
Typically, the 10Y UST trades at a premium to shorter duration USTs, reflecting expectation of future economic growth and inflation. When it yields less (known as an inverted yield curve), it signals slowing economic growth/recession concerns.
Inversion happened just 3 times this century – the Dot-Com crash, the GFC and following COVID-19. When the yield curve flips, it’s worth paying attention.
What’s happening now?
Since the high inflation of the 1980s, the 10Y UST has steadily declined, hitting a pandemic low of 0.62%. It has since bounced back, sitting around 4.00% for the past two years. This level is seen as a fair “neutral” rate, give or take 0.50%. High enough to price risk appropriately, without overly discouraging investment.
When markets panic, like we saw in April, the risk-free rate can spike off the back of an uncertain outlook. That sends ripples through global credit markets, including right here in Australia.
So what for Australian farmers?
Movements in the 10Y UST affect Australian borrowers in three key ways:
1. Interest Rates
Australian interest rates, both short and long term, closely track the US. The 10Y UST has a very high positive correlation of 0.94 with Australian 5 and 10 year bond yields, which are used to price fixed-rate loans and interest rate swaps. Even short-term Australian rates like the 3-month Bank Bill Swap Rate (BBSW) move in step with the US, albeit less tightly due to domestic influences (there is still a high positive regulation of 0.84 correlation).
2. Customer Margins
Lenders price loans based on what it costs them to borrow. Recent RBA research confirmed funding costs were the key determinant of the rates offered to borrowers.
Banks source a big chunk of their funding from wholesale markets, including the US. For example, in 2023, CBA raised roughly 25% of its’ funding offshore. When USTs rise, it gets more expensive for banks to borrow and they pass that cost onto borrowers. The opposite is true when the USTs fall.
3. Refinance Risk
Most Australian farmers borrower on short-term loans of 2 to 5 years. This makes refinancing a regular part of life. The risk is whether the debt can be refinanced when it falls due and on what loan terms.
Lender appetite to refinance is influenced not only by what’s been happening in the borrower’s business but also global markets. Even profitable farms can face tougher or more expensive loan terms if refinancing at an inopportune time e.g. during the GFC when global markets froze up and debt got more expensive.
The reality is timing matters. If your refinance falls in a volatile window, it could cost you.
The bottom line
You don’t need to be a bond market expert, but it pays to keep an eye on the 10-year US Treasury. This rate plays an important and often underappreciated role in determining your farm finances.
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