These bonds could be held to maturity anything from 3 months to 30 years. However, many bonds are bought and sold on financial markets causing price and yield to change. The price and yield of bonds give various indications of the state of the economy.
Firstly, if bond prices rise, yields decline. If bond prices fall, the yield rises. There is an explanation why here.
- Since last autumn the yield on the 10-year US Treasury bond has risen from just over 2pc to almost 4pc.
- UK Bond yields on 20 year and 30 year bonds are currently 4.75% (source: Government bonds at Bloomberg)
Thus rising bond yields means investors are less willing to hold government bonds. More people are selling bonds causing price to fall and yield to rise.
Why Bond Yields are Rising.Bond Yields can rise for a variety of Reasons.
1. People prefer riskier assets such as shares. (the recent rise in the stock market suggests some are switching from safe bonds to riskier shares)
2. There is fear of future inflation. If investors expect inflation to increase in the future, they will demand a higher interest rate (yield) to compensate for the decreased value of money in the future. Higher inflation may be feared because of:
- economic recovery
- Oil price shock.
- Quantitative easing to increase money supply
4. High levels of debt High levels of debt tend to reduce yields as more bonds are sold onto markets. The policy of quantitative easing is buying up some of these extra bonds. In theory this should push up prices and push down yields. But, quantitative easing also raises inflationary expectations.
Should We Worry about Rising Bond Yields?
- In a recession with a threat of deflation, bond yields are very low. If Rising bond yields are a sign of economic recovery and a return to normality, then this is a good sign.
- The aim of quantitative easing is to avoid deflationary pressures, therefore, if it is successful in avoid deflation and pushing inflation to more normal levels again we would expect this to have an effect on bond yields.
- If rising bond yields are because the government's credit rating is deteriorating, then this is a real cause for concern. It means it will be more difficult and expensive for governments to finance their large budget deficits in the future.
- Higher bond yields may push up long term interest rates on corporate bonds and mortgages. These higher interest rates will have the effect of slowing down economic growth and investment.