We recently showed 220 years of US Treasury bond yield history but all too often,
the
average investor is unfortunately unaware of the relationship between
bond yields (interesting on a relative-value perspective) and bond
prices (the thing that matters for your portfolio’s returns).
The two measures are inextricably linked obviously (a higher yield
implies a lower price and vice versa) but the relationship is not a
straight line – it has ‘convexity’. The following charts may help
understand the upside-downside changes from ‘yield’ movements, what the
Fed is doing to the relationship, and how inflation expectations impact
these changes.
Via Goldman Sachs:
Bonds are loans that investors make to governments,
municipalities or companies, which typically pay the investors a fixed
rate of interest until the bonds mature and the loans are repaid.
The most well-known US government bond is the 10-year US Treasury
bond, which matures ten years from the issue date. Right now, investors
can purchase a bond for $100 with a yield of about 1.7%, or about $1.70
per year – almost nothing! But
there is a bond market that moves daily, so the price of bonds will move depending on interest rates and the economy.
Although investors can simply hold the bond they purchased until
maturity and be paid back what they spent in full (plus the interest
they’ve received), they
can also sell the bond before maturity.
What they get back, however, will depend on interest rates at the time
that they sell. If interest rates have risen, then it will be harder to
sell their lower-yielding bond, and they will have to sell it for less
than they paid for it. If interest rates have declined, then other
investors will want to own the bond, and the seller can charge more than
they paid for it. So
bond holders don’t fare well when interest rates rise.
(more)
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