|Mandalika's scratchpad||[ Work blog @Oracle | My Music Compositions ]|
Bond prices and bond yields are inversely related — rising bond prices means lower yields, and falling bond prices imply higher yields.
When sold initially at auction by the US Treasury department, treasury notes or bonds will have a fixed face value and fixed interest rate. In the context of treasury bonds, the interest rate is usually referred as coupon rate, coupon percent rate or simply coupon.
Similar to stocks, bonds are resold on the open market or secondary market. Demand for those treasury bonds may push the price higher and the yield lower. The reason for the lower yield being upon maturity, treasury pays back just the face value along with the pre-determined interest rate. The current yield for any treasury bond can can be calculated as shown below.
Actual Annual Interest Current yield = ---------------------- * 100 Current Market Value
For example, if a treasury bond with a face value of $100 and an interest rate 3% was sold at a premium price for $101 due to demand, the current yield will be (3/101) * 100 = 2.97%
Implication of Treasury Yields:
Listed below are some high-level implications of the rising or falling treasury yields.
Rise in treasury yields may:
push the interest rate upwards on fixed-length mortages and loans with similar lengths. In other words, rise in treasury yields hurt borrowers by driving up the borrowing costs making longer-term loans such as housing, car loans less affordable. On the other hand, savers benefit by the rise in interest rates.
pose a threat to Governments with huge national debt by increasing the interest payments on that debt.
increase the value of the world's reserve currency — the US dollar as of today, which could attract foreign investment. As the returns on US dollar increase, the demand for US dollar grows worldwide.
negatively impact stock markets as investors may move out of those risky assets to less risky assets such as bonds
negatively impact precious metals such as Gold. The general theory is that since the returns on precious metals mainly depend on the demand for those metals, rise in bond yields and a subsequent strengthned US dollar make investing in precious metals less attractive.
Drop in treasury yields usually will have inverse effect of the rise in treasury yields. For example, drop in treasury yields may lead to decreased interest rates, which in turn may encourage borrowing and the resulting cash flow can result in real estate boom on the positive side, and can cause the inflation to go up on the negative side. Inflation is the rise in the prices of goods and services over time. Rise in interest rates in a inflation ridden nation may make things worse.
Note that the impact can be felt when there is a sudden and noticeable movement in yields in either direction. Once stabilized, people may get used to the new normal, and some of the things may go back to the way there were. For example, sudden upward surge in treasury yields may drive investors away from Gold - but once the knee-jerk reaction subsides, investors may return and continue trading Gold. After all, Gold is a precious metal with lots of demand worldwide.
Source: various including Investopedia