By William Cao Edited by Swastik Patel
Overview/Introduction
It is safe to say that the stock market is currently not seeing its brightest days, as index funds such as the S&P 500 are down by more than 20% year to date due to a multitude of factors. Generally, when the stock market is down in a similar fashion, investors tend to seek another, safer option, in this case bonds. Below is a tracker of the US 10-year treasury yield, which reflects the economy in the past three years. Let’s take a deeper look into how these bond market prices fluctuate.
via MarketWatch
Bond Yields
The yield on a bond, to put it simply, is the rate of return given to a bondholder. In fact, the yield has the greatest impact on the price and rating of a bond. A bond’s price indicates the value still present in a bond since the yield measures the discount rate of its cash flows. Bond yields and prices are inversely proportional with one another (bond prices rise, bond yields fall). Government bond yields can also serve as a general indication of how expectations and interest rates are trending in the US.
Macroeconomic Factors
Interest rates have a direct impact on bond prices: bond yields decrease in direct proportion to interest rates, so bond prices will change together with interest rates. Another factor that can lead to fluctuating bond prices is inflation, which results in a higher interest rate. The cost of borrowing bonds increases when interest rates rise, and as a result there is less demand for lower-yield bonds, driving down prices. Fun fact: these interest rates are directly controlled by the US Federal Reserve.
Conclusion
Bond market prices currently are fluctuating due to two main factors: interest rates and their specific yield. Interest rates are mainly controlled by the US Federal Reserve, especially in inflation environments, where interest rates are raised. The yield on a bond is the rate of return given to a bondholder and types of bond yields such as the government can give us an outlook of how expectations of interest rates are looking like in the US. When looking into bond markets, it is often beneficial to look at the change in interest rates and yield. Some ways to do this can be to first check out the treasury yields (such as the one linked above) and stay up to date with all of the macroeconomic news.
