What is a Constant Maturity Treasury (CMT)?
A Constant Maturity Treasury, or CMT for short, is a special interest rate that the Federal Reserve calculates and shares with everyone. The Federal Reserve is like the central bank of the United States. It’s their job to monitor interest rates and the economy.
How the CMT works
The CMT tells us what the interest rate or “yield” would be on a United States Treasury bond or note if it was brand new today. Treasury bonds and notes are ways the US government borrows money.
Let’s say there is a 10-year Treasury note that was first sold one year ago. It earned an interest rate of 3% at that time. But interest rates change every day! If a brand new 10-year Treasury note was sold today, it might earn 4% interest instead.
The Federal Reserve figures out what that brand-new interest rate would be each business day. It does this for Treasury securities that come due in different lengths of time – like 1 year, 2 years, 3 years, 5 years, 7 years, 10 years, 20 years, and 30 years. These periods are called “maturities.”
Constant maturity means the length of time stays the same
The “constant maturity” part of CMT means that the length of time until the Treasury security is paid back (its maturity) stays the same when the Federal Reserve calculates the interest rate each day.
In our example, the 10-year Treasury note will mature in 9 years since a year has passed. However, for the 10-year CMT rate, the Federal Reserve will always look at the interest rate for a Treasury that matures in 10 years, not 9 years. The 10 years stay constant.
Why the CMT matters
Important for comparing interest rates
The CMT helps us compare apples to apples when looking at interest rates over time. Interest rates go up and down, but by always looking at what the rate would be for a brand new Treasury security with the same maturity, we can see how rates are changing in a fair way.
It’s sort of like tracking the price of a gallon of milk at the store. The price might change over time, but you’re always looking at the cost for the same amount of the same thing – one gallon of milk. With CMTs, we’re always looking at the interest rate for a Treasury with the same maturity length.
Used in some special financial deals
There is a special kind of financial agreement called a constant maturity swap. In this swap, one person agrees to pay the other person a fixed interest rate. The second person agrees to pay a floating interest rate that changes based on the CMT rate.
The CMT rate is used to decide what that floating interest rate payment will be. As the CMT rate moves up or down, so does the floating rate in the swap. This lets the two people in the swap deal with changing interest rates in a way they both agreed to.
How the Federal Reserve calculates CMTs
Gathering Treasury price data
Every day, the Federal Reserve looks at data on the prices that US Treasury bonds and notes are trading at in the market. Banks and other big financial players buy and sell huge amounts of these Treasury securities, so there is always new price data.
Figuring out the yields
The Federal Reserve uses fancy math to figure out what interest rate or “yield” matches up with those trading prices for each maturity length. If prices are high, yields are usually low, and the opposite is true too.
This math is complex, but just know that at the end, the Federal Reserve has figured out the current yields for brand new Treasury securities at each of those fixed maturity lengths – 1 year, 2 years, 3 years, and so on.
Sharing the CMT rates
The last step is easy – the Federal Reserve publishes all these CMT rates on their website for everyone to see! They update the rates every business day.
Banks, businesses, and investors can then use these CMT rates to help them make decisions. They might compare the CMTs to other interest rates or use them in financial agreements like those constant maturity swaps we talked about.
A real-world example
Imagine that a big company is thinking about borrowing $10 million from a bank to build a new factory. The bank offers them a 10-year loan, but the company is worried that interest rates might go up a lot over those 10 years. Higher rates would mean bigger interest payments!
The company could use a 10-year constant maturity swap to protect against that risk. They might agree to pay the bank a fixed rate of 4% on the $10 million for the whole 10 years. The bank would agree to pay the company the 10-year CMT rate, which would change each year.
If interest rates go up and the 10-year CMT rate climbs to 6%, the bank has to pay the company the difference between 6% and 4% on that $10 million. That helps cancel out the higher interest costs the company faces. But if rates fall and the CMT drops to 2%, the company has to pay the bank the difference between 4% and 2%.
The CMT lets them set up this deal and understand how interest rate changes will affect their payments. Both sides can weigh the risks and possible outcomes to decide if the swap is a smart move.
To sum it all up
Constant Maturity Treasury rates are an important tool that the Federal Reserve uses to give everyone a clear, fair look at how US Treasury interest rates are changing over time. By focusing on what the rates would be for brand new Treasury securities every day, CMTs help us compare interest rates without worrying about the age of the bond or note.
CMTs also play a key role in some special financial agreements that let people manage the risks that come with changing interest rates. A constant maturity swap is the main example, where CMTs are used to figure out the payments.
Lots of people pay attention to CMTs – from banks to businesses to investors. They are one more piece of the puzzle that helps everyone understand what’s happening with interest rates in the world of finance and the broader economy.
