Treasury Notes
Treasury Notes
Treasury notes are the intermediate segment of the government bond market. They mature in 2, 3, 5, 7, or 10 years and pay coupons (interest) every six months until maturity. A 5-year Treasury note purchased at par with a 4% coupon yields 2% every six months for five years, plus your principal at maturity. They bridge the gap between T-bills (short-term, no coupons) and Treasury bonds (long-term, 20–30 year), making them the most commonly held direct US government securities.
Key takeaways
- Treasury notes exist in 2-, 3-, 5-, 7-, and 10-year maturities and are auctioned regularly by the US Treasury
- They pay semi-annual coupons and offer price stability relative to longer bonds, making them ideal for intermediate bond allocations
- The 10-year Treasury note yield is the market's consensus expectation for future growth, inflation, and risk premiums
- Duration on a 5-year note is roughly 4.5 years; on a 10-year note, roughly 8–9 years, meaning price swings are moderate
- Treasury notes can be bought directly via TreasuryDirect, at brokerages, or through bond ETFs
The maturity spectrum: where notes fit
The US Treasury issues securities across the entire maturity spectrum. T-bills cover 4 weeks to 52 weeks. Notes cover 2 years to 10 years. Bonds cover 20 and 30 years. (A few decades ago, the Treasury also issued 15-year bonds, but these are no longer issued, though some still trade in the secondary market.)
In the intermediate bucket—bonds maturing in 2 to 10 years—Treasury notes are the benchmark. A typical 60-40 investor might hold 30% bonds, split between government and investment-grade corporate. Of the 15% government allocation, the investor might hold 8% in a 10-year note or a broad Treasury fund (covering 2–10 year notes), 4% in longer Treasuries or TIPS, and 3% in short-term bills or a money-market fund.
The 10-year note is especially important. It is the most liquid government security outside of T-bills and is used as the market's benchmark for intermediate-term risk and growth expectations. When the Fed raises rates, the 10-year yield often rises (though not always—long yields can fall if growth expectations decline faster than short rates rise). When recession fears mount, the 10-year yield often falls as investors shift into safety. News anchors cite "the 10-year Treasury yield" as the signal of bond-market health; mortgages, student loans, and corporate bond yields all track it within 1–3 percentage points.
Auction schedule and ownership patterns
The US Treasury holds auctions for Treasury notes on a regular schedule:
- 2-year notes: weekly (Mondays)
- 3-year notes: monthly
- 5-year notes: weekly (Wednesdays)
- 7-year notes: monthly
- 10-year notes: weekly (Thursdays)
Total monthly supply of new notes often exceeds $100 billion. This enormous float means that buyers include central banks (the Federal Reserve, Bank of Japan, European Central Bank), commercial banks, mutual funds, pension funds, foreign governments, and individual retail investors.
As of 2024, foreign central banks and governments own roughly 30% of all outstanding US Treasuries (over $7 trillion). Japan and China are the largest foreign holders, buying notes as part of their foreign exchange reserves and economic policy. When a foreign central bank reduces its Treasury holdings—as China did gradually from 2013 to 2017—it can put upward pressure on yields. Conversely, purchases by major central banks can suppress yields.
Price dynamics and interest-rate sensitivity
A Treasury note's price moves inversely to interest rates. If you own a 5-year note yielding 3.5% and new 5-year notes are issued at 4.0%, your note is now worth less because its coupon is below market. Its price falls from par ($100) to perhaps $98 to match the new 4.0% yield. The magnitude of the price change depends on duration.
Duration on a 5-year Treasury note (assuming a mid-range coupon like 3.5%) is typically 4.5 years. This means a 1% rise in yield causes the price to fall roughly 4.5%. A 10-year note with a coupon of 4.0% has a duration of roughly 8.5 years, meaning a 1% rise in yields causes the price to fall roughly 8.5%. A 2-year note with a coupon of 5% has a duration of roughly 1.95 years, meaning a 1% rise causes the price to fall roughly 1.95%.
From 2021 to 2022, the Federal Reserve raised rates from near zero to over 4%. A 10-year Treasury investor holding a 1.5% coupon note saw the market value of the note plummet. A bond originally worth $100 might fall to $90 as yields rose. Investors who sold during 2022 realized losses. Those who held to maturity received their full principal and the 1.5% coupons, but they foregent the opportunity to earn 4% on a new note. This is the cost of owning longer bonds in a rising-rate environment.
Yields and real returns
As of 2024, a 10-year Treasury note yields approximately 4.0–4.2%. With inflation expectations around 2.3%, the real yield (yield minus expected inflation) is roughly 1.7–1.9% per year. This is positive but modest. In the early 2020s, with inflation at 3% and 10-year yields at 1.5%, real yields were negative, meaning bondholders were losing purchasing power each year.
Real yields on Treasury notes fluctuate with inflation expectations and growth forecasts. In a strong economy, investors expect the Federal Reserve to keep rates higher for longer, pushing long-term yields up. In a weak economy or deflation scenario, investors expect future rates to be lower, pushing yields down. A 10-year real yield of 2% or higher is considered attractive to equity investors, making bonds competitive with stocks.
Buying notes directly or through funds
You can buy Treasury notes in several ways. Via TreasuryDirect, you can bid for newly issued 2-year, 3-year, 5-year, 7-year, and 10-year notes at auction. The process mirrors T-bill purchases: you set up an account, submit a non-competitive bid, the auction yields a rate, and you pay the corresponding price. Minimum investment is $100.
At a brokerage (Vanguard, Fidelity, Schwab), you can buy newly issued notes at auction or existing notes in the secondary market. Secondary-market purchases involve a small bid-ask spread (typically $0.25–$1 per $1,000 par) but offer more flexibility: you can buy any maturity or coupon you want, not just the newly issued securities.
For passive investors, a Treasury note ETF is simpler. Vanguard Intermediate-Term Treasury ETF (VGIT) holds a mix of notes with maturities from 1 to 10 years, offers daily liquidity, and has an expense ratio of 0.04%. iShares Treasury 5-7 Year ETF (SHV) focuses on the 5–7 year sweet spot and has an expense ratio of 0.05%. These funds auto-rebalance and reinvest coupons, simplifying management.
The note ladder strategy
Many individual investors use a "note ladder" strategy: buying one note of each maturity (2-year, 3-year, 5-year, 7-year, 10-year) and holding to maturity. As each note matures, they reinvest the proceeds in a new 10-year note (or whatever the longest maturity is). Over a decade, this strategy ensures you're buying and selling at different points in the rate cycle, averaging your yields and reducing the risk of being all-in at a market peak.
For example, you start in January 2024 with a 2-year, 3-year, 5-year, 7-year, and 10-year note. In January 2026, the 2-year matures; you reinvest that amount in a new 10-year. In January 2027, the original 3-year matures; you reinvest in a new 10-year. And so on. Over 10 years, you'll buy notes at every point in the rate cycle. Historical data shows that buy-and-hold ladders produce stable, predictable returns across bull and bear bond markets.
Inflation-adjusted yields and the breakeven rate
A key market signal is the "breakeven inflation rate"—the spread between a nominal 10-year Treasury note yield and a 10-year TIPS (Treasury Inflation-Protected) yield. If the nominal 10-year yield is 4.0% and TIPS yield 1.8%, the implied inflation expectation is 2.2% per year. This tells you what the market thinks about future inflation. In 2022, breakeven rates spiked to 2.7%, reflecting inflation fears. In 2024, they stabilized around 2.2%, suggesting inflation has cooled to the Fed's 2% target.
For investors, this matters because it reveals whether bonds are cheap or expensive. When breakeven rates are low (under 2%), the market is pricing in deflation or very low inflation, which is unusual. When they're high (over 3%), the market is pricing in high inflation, which may or may not materialize. A savvy investor watches these rates to decide whether nominal notes or TIPS offer better value.
Volatility clustering and flight-to-quality
Treasury note prices exhibit a dynamic known as "flight-to-quality." When stock markets crash or credit concerns mount, investors sell risky assets and buy Treasuries, pushing note prices up and yields down. In March 2020, as the COVID-19 pandemic sparked a stock crash, Treasury note prices soared despite the Fed's emergency rate cuts. Risk-off sentiment pushed flows toward Treasuries.
Conversely, in risk-on environments (strong earnings, low unemployment, low inflation), investors shift out of Treasuries and into stocks and credit. Treasury note prices fall and yields rise. This anti-correlation with equities is why bonds belong in diversified portfolios—they tend to hold up when stocks fall, providing ballast.
Tax efficiency in taxable accounts
Treasury note interest is subject to federal income tax but exempt from state and local income taxes. In high-tax states like California (state rate: 13.3%) and New York (state rate: 10.9%), this exemption is valuable. A 4% yield on a Treasury note is equivalent to a 5.6% yield on a taxable corporate bond (assuming a combined federal + state rate of 40%) in California. For this reason, many high-income earners in high-tax states overweight Treasuries relative to corporate bonds.
In tax-deferred accounts (401(k), IRA, HSA), there is no state-tax benefit, so Treasuries compete equally with corporate bonds on expected return. Some investors deliberately hold Treasuries in taxable accounts and higher-return securities in tax-deferred accounts to minimize tax drag.
Duration management and rate forecasts
Professional bond managers obsess over duration—the weighted average time to receive cash flows. A 5-year Treasury note with a 3% coupon has a duration of roughly 4.5 years. If a manager believes rates will rise, they might reduce their average portfolio duration to 3 years by selling some 10-year notes and buying 2-year notes. If they believe rates will fall, they might extend duration to 6 years by buying 10-year notes.
Most retail investors need not engage in this level of tactical trading. A simple approach: for a stock-heavy portfolio, hold intermediate (5–7 year) Treasury notes. For a more conservative portfolio, extend to longer maturities. Avoid trying to time whether rates will rise or fall; instead, hold a diversified mix across maturities and let dollar-cost averaging work over time.
The Treasury curve and recession signals
The "yield curve" is a plot of yields across all maturities. In normal times, longer maturities yield more, reflecting the extra risk and opportunity cost of locking up capital. When the 2-year Treasury note yields more than the 10-year, the curve is inverted. Inverted curves have historically preceded recessions.
The curve inverted in 2022, with 2-year notes yielding over 4.2% and 10-year notes yielding 3.8%. This inversion signaled that markets expected the Fed to eventually cut rates, a move that typically only happens in recessions. The following year, economic growth did slow, though a full recession did not materialize (at least through 2024). Investors should monitor curve inversions as a warning sign, though they are not a perfect recession predictor.
Conclusion: the bread and butter of bond investing
Treasury notes are the core of most bond allocations. They offer modest real yields, near-zero credit risk, high liquidity, and tax advantages relative to corporate bonds. Whether you're building a ladder of individual notes, buying a Treasury note ETF, or holding notes through a 401(k), they should form the backbone of your fixed-income allocation. As you build investment experience, you'll learn to navigate note auctions, duration management, and tax optimization—but the foundation remains the same: buy and hold government notes to maturity or sell if your outlook shifts.
Process diagram
Related concepts
Next
Treasury bonds extend the government spectrum to 20 and 30 years, offering higher yields than notes but with significantly more interest-rate risk and a narrower investor base.