Treasury Bond Prices and Yields

Basic Understanding of Bond Prices and Yields

  • Treasury Security:Loan to the US government
  • Yield is calculated by expected money back (interest) after loaning said amount
  • As demand increases on the bond, the price of the bond increases and thus decreases yield

Yield Curve

  • Leading indicator to the market
  • Yield % Y Axis, Bond Maturity in X Axis
  • Liquidity Premium Theory: Longer term has higher risk because of liquidity (ties up your money for a longer period of time)
  • Flat curve = signs of recession: Happens when people have bought so many longer-term bonds that long term bonds is not as attractive as short-term bonds. Investor believes there is greater risk out there that outweighs the risk of longer-term bonds. Example includes expectations that future interest rates to fall or other investments to perform poorly.

Bond Yields and the Stock Market

  • Equities on average do fairly well when yields rises
  • But when yields are starting with very low levels, and get above a certain threshold (3-4% historically), then it becomes negative to the equities market
  • This is because inflation is increasing from elevated levels and there is a correlation to 10-year treasury yield and inflation (10-year treasure yield being forward looking; inflation being backwards looking)
  • Higher bond yields will affect the highest leverage stocks with the most debt crushing these companies the most
  • If yield goes up, less demand to buy stocks because treasury bonds are considered risk free
  • 10 year => over 1.5%, stocks tend sell off
  • 5 year => over 0.7%, stocks tend to sell off
  • 10-year treasury yield – inflation rate = real interest rate
  • 10-year treasury yield = nominal

How does Bond Yields Rise/Fall?

  • Stimulus by selling treasury bonds (supply of bonds goes up, price goes down, rates go up)
  • Strong growth is coming to economy (less buyers of bonds, leads to higher yields, in return hurts stocks)
  • Expectation of inflation to come (no demand for bonds since inflation is higher than bond interest rates, then expected future returns of bonds is negative)
  • Expectations that government will raise rates in the future