The Effect of Gross Domestic Product on Treasury Bill Interest Rates

by Dennis Hartman

Treasury bills, also known as T-bills, are short-term investments in the government of the United States. They typically last several months before maturing and returning money to investors. Since T-bills are sold at a discount rate, investors earn interest, or yields, by selling them for more than they cost to buy. However, the value of T-bill yields depends on many factors, some of which are tied to metrics such as gross domestic product.

Gross Domestic Product Definition

Gross domestic product (GDP) refers to the total value of the goods and services that a country produces in a given period of time, usually one quarter or year. GDP rises and falls based on a number of factors, including consumer spending, financial markets and international trade. According to New York University, GDP is the most important economic indicator since it gives such a broad view of a national economy. Typical annual GDP growth in the United States is between 2.5 and 3 percent.

Supply and Demand

The most direct impact GDP has on T-bill yields comes from the law of supply and demand. T-bills are sold at a discount rate, and when supply is low or demand is high, investors are willing to pay more for them This reduces the yield they receive when they sell. A declining GDP can indicate new risks in financial markets that drive investors toward T-bills, which have virtually no risk.

Via Monetary Policy

GDP can affect T-bill interest rates through its impact on monetary policy. This occurs primarily when the Federal Reserve Board, using GDP and other financial data, elects to raise or lower interest rates for American banks. This type of action has a number of effects, including controlling inflation and, in the process, altering T-bill yields. Inflation refers to a general rise in the cost of goods, which makes money worth less based on its buying power. As GDP grows, especially if it exceeds analyst expectations, it indicates that an economy reaches its full capacity and drives up T-bill interest rates.

Secondary Markets

The government offers T-bills for sale through auctions, allowing buyers to set their own prices and altering the yield for each group of bills sold. However, T-bills are also bought and sold on secondary markets. This gives investors, who may or may not make purely rational decisions, a great deal of control over how much T-bills are worth in terms of their interest rates. The Federal Reserve Bank of San Francisco notes that since the 1950s, even the expectation of inflation has tended to drive up T-bill rates. Ultimately, any type of change in GDP can generate increased T-bill demand, and push down yields, depending on how investors react.

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