The hidden power of capital gains in US Treasury investments

For many investors, U.S. Treasuries are synonymous with safety and fixed income, providing a stable stream of coupon payments. However, a less-appreciated source of return is the capital gain realized through principal appreciation. This occurs because bond prices move inversely to interest rates. When the prevailing market interest rates fall, the value of existing bonds with higher, fixed coupon rates rises in the secondary market. If a bond is purchased at par and subsequently sold at a premium due to a drop in yields, the investor captures a capital gain in addition to the accrued interest. This mechanism transforms Treasuries from simple income generators into instruments with significant price volatility and appreciation potential when the market anticipates, or begins to realize, a decline in borrowing costs (see Figure 1).

The scale of this principal appreciation is not uniform across all maturities; rather, it is directly tied to the bond’s duration, which is closely correlated with its time to maturity. Simply put, for an identical percentage point decrease in interest rates, a bond with a longer maturity will experience a disproportionately larger increase in price than a short-term note. This principle stems from the mathematics of present value. Longer-dated bonds possess cash flows (coupons and principal repayment) that are discounted over a longer period. As the discount rate (the prevailing interest rate) decreases, the present value of those distant cash flows increases dramatically. This sensitivity makes longer-maturity Treasuries the most potent way to capitalize on falling rates, embodying the core risk/reward trade-off known as interest rate risk.

Understanding this duration-based leverage is critical for tactical investors. In environments where the Federal Reserve or global economic forces are signaling a shift toward monetary easing, taking a substantial position in long-term Treasuries—such as the 20- or 30-year bonds—can unlock significant capital gains. (This can be done indirectly by investing in funds such as the VGLT.) If a bond with a 20-year duration, for instance, sees its yield fall by just 100 basis points (1.00%), its principal value will appreciate by roughly 20%. This leverage allows investors to achieve equity-like returns from a sovereign debt instrument during periods of yield decline. Therefore, an informed strategy recognizes that long-term Treasuries are not merely hold-to-maturity assets, but powerful tools for capital appreciation in anticipation of a rate-cutting cycle.