U.S. Treasuries rallied as investor unease about China and the timing of the Federal Reserve's first interest rate hike since 2006 spurred demand for safe-haven assets. In August, China's unexpected currency devaluation raised fears that its government was struggling to manage a slowing economy and sparked a sell-off in riskier assets, particularly emerging markets securities and currencies. During the worst selling in equities, Treasuries enjoyed strong demand that pushed the 10-year Treasury note's yield down to almost 1.90%. (Bond prices and yields move in opposite directions.) Treasury yields then increased until the Fed's policymaking committee ignited another rally in Treasuries by opting not to increase the federal funds rate at its September meeting, citing global developments that have tightened monetary conditions.
The U.S. Treasury Long-Term Fund returned 5.11% in the quarter compared with 5.08% for the Barclays U.S. Long Treasury Bond Index and 3.02% for the Lipper General U.S. Treasury Funds Average. For the 12 months ended September 30, 2015, the fund returned 7.32% versus 8.80% for the Barclays U.S. Long Treasury Bond Index and 5.46% for the Lipper General U.S. Treasury Funds Average. The fund's average annual total returns were 7.32%, 5.36%, and 6.62% for the 1-, 5-, and 10-year periods, respectively, as of September 30, 2015. The fund's expense ratio was 0.51% as of its fiscal year ended May 31, 2015.
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Current performance may be lower or higher than the quoted past performance, which cannot guarantee future results.
Share price, principal value, and return will vary and you may have a gain or loss when you sell your shares.
The fund invests at least 85% of its assets in Treasuries but maintains small positions in other securities backed by the U.S. government, including Treasury inflation protected securities (TIPS) and Ginnie Mae mortgage-backed securities (MBS). TIPS provide some inflation protection, while our MBS holdings provide added yield over Treasuries, decent liquidity, and diversification. The fund's duration, which measures its sensitivity to changes in interest rates, was slightly shorter than that of the benchmark, as we anticipate higher interest rates in light of the strengthening U.S. economy and a less accommodative Fed.
T. Rowe Price Chief U.S. Economist Alan Levenson believes that the Fed could raise the fed funds rate as soon as December. However, we don't expect a severe Treasury sell-off to occur once the Fed starts increasing rates. While we expect the strengthening U.S. economy to put upward pressure on rates, muted inflation and the strong dollar will likely continue to sustain strong demand for Treasuries and help restrain U.S. yields. Large-scale quantitative easing efforts in Europe and Japan could also hold longer-term yields down globally by limiting the supply of high-quality government bonds. Finally, we expect that the pace of U.S. rate hikes will be gradual and the terminal rate fairly low compared with previous tightening cycles, giving investors time to adjust to the new environment.