FX Trader's Guide To Bond Prices & Bond Yields
A quick guide on bonds, bond prices and bond yields for FX traders.
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When we talk about bonds, usually we are referring to government bonds, now the reason why governments issue bonds is to raise capital.
So the government, let’s take the US as an example, needs to raise money, so they issue new government bonds or order to borrow money from the willing lenders, which are those who buy the bonds, but of course they need to pay you something for lending them the money, they need to give you some interest.
When you buy a bond from the government for $1000 at par value, you also get what it called a coupon, that is a fixed payment from the government as interest for borrowing them the money. So imagine you buy a bond at an interest rate of 3%, that would mean you get paid $30 every year in interest for the $1000 you have lent to the government.
Now you can calculate the yield for that bond by taking your coupon payment of $30 and dividing that with the price you paid for the bond, which is $1000, that gives you a yield of 3%.
So, from this you can see that there is an inverse relationship between bonds and their yields. When bond prices go up, their yields will go down, when bond prices go down, their yields will go up.
Now, this is important because bonds trade in a primary and secondary market, once bonds have been issued and bought they can be traded like any other asset in the secondary market. And bonds will be bought and sold for many different reasons based on their quality and based on the economy.
Now, the quality of a country’s bonds are determined by a couple of factors, one of them is default risk, so how likely is this government from defaulting on their risk, now for countries like the US and Germany, they have a very slim chance of defaulting on their debt, so their bonds will be seen as more creditworthy if that makes sense.
That’s why countries that has low creditworthiness will have much higher bond yields because they need to offer more attractive yields for their investors.
Other things to consider for bonds of a government is the current economic climate. When there are expectations of rising or falling interest rates this highly affects the bond market.
AAA rated government bonds from the US, are considered as one of the safest investments money can buy, because the default risk is very low. So, when bond investors thinks the economy is slowing, they will start accumulating bonds from a safe haven point of view, the increase in demand for bonds pushes up the bond prices, and thus pushing down the bond yields.
So, the expectation of a slowing economy means the market will start expecting lower interest rates which is another reason for bond holders to buy bonds while the interest rates are more attractive, for example if you are an investor that just wants to buy and hold bonds like a pension fund, then buying when the cycle starts to slow means you can lock in much higher yields for your bonds, and of course the more investors that buy at lower prices the more demand and the higher prices will go.
If you are an investor that just wants rotate temporarily out of stocks and into bonds, then buying them as a safe haven makes sense, but importantly in both cases the result will mean that bond demand will grow and thus the yields will move lower.
So, bond demand usually goes up when the economy is expected to slow, and that means the yields are expected to fall, and bond demand usually goes down when the economy is expected to rise, and that means the yields are expected to rise.
So, when we consider this from a more intraday perspective, rising bond prices or lower yields are indicative of risk-off flows and falling bond prices or higher yields are indicative of risk-on flows.
Something that also affects bond yields, especially at the back end of the curve, so you’re 10-year and up is inflation.
So, what usually happens to the bond market with inflation data and inflation expectations are bond yields usually rise when inflation expectations rise as investors rotate out of bonds and into higher yielding assets.
But, alternatively, what some investors like to do, if they still want to keep their risk low by not investing in stocks but keep their bonds, they can buy inflation protected bonds which is called TIPS.
As Gold is also considered as a safe-haven, and also considered as an inflation hedge, you usually see Gold very strongly correlated with inflation protected treasuries or TIPS.
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If you find this content helpful, you’ll love Forex Source.
There’s a link below were you can learn more about it
https://bit.ly/2HFykNd
----
We interpret and explain price moves in real-time, 24 hours a day. Our team of analysts produce text, video and audio commentary.
You understand the markets and trade with confidence. Learn more at our website here: https://bit.ly/2HFykNd
-----
When we talk about bonds, usually we are referring to government bonds, now the reason why governments issue bonds is to raise capital.
So the government, let’s take the US as an example, needs to raise money, so they issue new government bonds or order to borrow money from the willing lenders, which are those who buy the bonds, but of course they need to pay you something for lending them the money, they need to give you some interest.
When you buy a bond from the government for $1000 at par value, you also get what it called a coupon, that is a fixed payment from the government as interest for borrowing them the money. So imagine you buy a bond at an interest rate of 3%, that would mean you get paid $30 every year in interest for the $1000 you have lent to the government.
Now you can calculate the yield for that bond by taking your coupon payment of $30 and dividing that with the price you paid for the bond, which is $1000, that gives you a yield of 3%.
So, from this you can see that there is an inverse relationship between bonds and their yields. When bond prices go up, their yields will go down, when bond prices go down, their yields will go up.
Now, this is important because bonds trade in a primary and secondary market, once bonds have been issued and bought they can be traded like any other asset in the secondary market. And bonds will be bought and sold for many different reasons based on their quality and based on the economy.
Now, the quality of a country’s bonds are determined by a couple of factors, one of them is default risk, so how likely is this government from defaulting on their risk, now for countries like the US and Germany, they have a very slim chance of defaulting on their debt, so their bonds will be seen as more creditworthy if that makes sense.
That’s why countries that has low creditworthiness will have much higher bond yields because they need to offer more attractive yields for their investors.
Other things to consider for bonds of a government is the current economic climate. When there are expectations of rising or falling interest rates this highly affects the bond market.
AAA rated government bonds from the US, are considered as one of the safest investments money can buy, because the default risk is very low. So, when bond investors thinks the economy is slowing, they will start accumulating bonds from a safe haven point of view, the increase in demand for bonds pushes up the bond prices, and thus pushing down the bond yields.
So, the expectation of a slowing economy means the market will start expecting lower interest rates which is another reason for bond holders to buy bonds while the interest rates are more attractive, for example if you are an investor that just wants to buy and hold bonds like a pension fund, then buying when the cycle starts to slow means you can lock in much higher yields for your bonds, and of course the more investors that buy at lower prices the more demand and the higher prices will go.
If you are an investor that just wants rotate temporarily out of stocks and into bonds, then buying them as a safe haven makes sense, but importantly in both cases the result will mean that bond demand will grow and thus the yields will move lower.
So, bond demand usually goes up when the economy is expected to slow, and that means the yields are expected to fall, and bond demand usually goes down when the economy is expected to rise, and that means the yields are expected to rise.
So, when we consider this from a more intraday perspective, rising bond prices or lower yields are indicative of risk-off flows and falling bond prices or higher yields are indicative of risk-on flows.
Something that also affects bond yields, especially at the back end of the curve, so you’re 10-year and up is inflation.
So, what usually happens to the bond market with inflation data and inflation expectations are bond yields usually rise when inflation expectations rise as investors rotate out of bonds and into higher yielding assets.
But, alternatively, what some investors like to do, if they still want to keep their risk low by not investing in stocks but keep their bonds, they can buy inflation protected bonds which is called TIPS.
As Gold is also considered as a safe-haven, and also considered as an inflation hedge, you usually see Gold very strongly correlated with inflation protected treasuries or TIPS.
-----
If you find this content helpful, you’ll love Forex Source.
There’s a link below were you can learn more about it
https://bit.ly/2HFykNd
