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The 10 year Treasury rate is often the only piece of market data reported by the media about the bond market. Just like the Dow Jones Industrial Average is an extremely flawed measure of stock market performance, the 10 Year Treasury often misrepresents the performance of the bond market. In fact, the value of the 10 Year Treasury could rise in value while the value of the your "core bond fund" could fall.

Why is the yield on the 10 year Treasury misleading?

The shape of the yield curve matters, not just one point of data. Yields for all bond maturities don't move together. You could have a situation where yields on short maturity bonds increase and longer dated maturities decrease in yield.

The 10 year Treasury is more sensitive to changes in interest rates than the bond funds in your portfolio.

The 10 year Treasury has a maturity of 10 years and duration of 9.1 years. Duration is a measure of interest rate risk. The largest bond mutual fund in the world, The PIMCO Total Return Fund BOND, has an average maturity of 5.9 years and a duration of 4 years. The largest bond ETF in the world, BND, has an average maturity of 7.1 years and a duration of 5.2 years. What happens to the 10 year treasury rate is less important to investors in the largest bond mutual fund and ETF than what happens to interest rates in the 5 to 7 year maturity range.

The 10 year Treasury provides no information on credit risk.

If you invest in corporate bonds, your returns have to do with changes in the yields on Treasuries and the premium (additional yield) that investors demand to hold bonds which are riskier than treasuries. This is also known as the credit spread. Credit spreads can often compress and widen. Changes in the credit spread, particularly for high yield bonds, can overwhelm the impact of changes in treasury yields.

What should you follow instead of the 10 Year Treasury Yield?

If you want to follow just one ETF, I would follow the Vanguard Total Bond Market Fund.

While this ETF will not provide information on the shape of the yield curve, its average maturity and duration should be much closer to the bonds / bond funds in your portfolio. Also, while the majority of BND is invested in U.S. government guaranteed bonds, it does contain a sizable amount of investment grade corporate debt. This means gains and losses in BND do contain some information about changes in the credit risk premium.

If you want to follow changes in the shape of the yield curve, I would follow the following ETFs from iShares: SHY, IEF, and TLT which hold U.S. government bonds of different maturities.

ETF

Maturities

Yield Curve

SHY

1-3 Years

Short Part

IEF

7-10 Years

Middle Part

TLT

Over 20 Years

Long Part

What it means:

  • If all three ETFs are moving up in value, overall interest rates are falling.
  • If all three ETFs are moving down in value, overall interest rates are rising.
  • If SHY is rising and TLT is falling in value, the yield curve is steepening.
  • If SHY is falling and TLT is rising, the yield curve is flattening.
  • If you want to follow the municipal bond market, you will should watch MUB and IEF.

MUB is the largest ETF that invests in municipal bonds on a national basis. The price movement of MUB is a good indication of how the municipal market is doing. However, municipal bond prices are usually measured against treasuries. MUB and IEF have similar maturities (respectively 6.1 and 7.4 years) which make comparing the two ETFs useful.

If the price of MUB is moving higher at a faster rate than IEF (or MUB is rising and IEF is falling), then municipal bonds are outperforming the market.

If the price of IEF is moving higher at a faster rate than MUB (or MUB is falling and IEF is rising), then municipal bonds are underperforming the market.

If you want to follow the high yield market, you should watch JNK and BND.

JNK is one of the two largest high yield bond ETFs, while BND measures the entire high quality side of the U.S. bond market. With high yield bonds (when yields are very low), the credit risk premium rather than interest rates drives performance.

If the price of JNK is moving higher at a faster rate than BND (or JNK is rising and BND is falling), the risk premium is compressing and the market is favoring riskier assets.

If the price of BND is moving higher at a faster rate than JNK (or JNK is falling and BND is rising), then the risk premium is widening and the market is favoring less risky assets.

For more on how to invest in bonds see our free guide to the basics of bond investing here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.