Why Do Government Bond Yields Go Up? Bond yields and prices move in different directions. The sale of bonds, and specifically UK government bonds, or gilts, has pushed yields up recently. Other factors that can support bond yields include interest rates and inflation/interest-rate expectations.
If the economy grows rapidly and inflation is rising, bond yields tend to follow suit. Bond yields also tend to rise if the Federal Reserve, the nation's central bank, raises the short-term interest rate it controls, the federal funds target rate.
The U.S Treasury sells bonds via auction and yields are set through a bidding process.1 Prices for the 10-year bond drop when confidence is high, which causes yields to rise. This is because investors feel they can find higher-returning investments elsewhere and do not feel they need to play it safe.
Fueled by uncertainty. The bad news: Yields might also be rising for some less-good reasons, including growing uncertainty about the longer-term outlook for interest rates and inflation. Concerns about the federal budget deficit could also be a factor.
Bonds rated below Baa3 by ratings agency Moody's or below BBB by Standard & Poor's and Fitch Ratings are considered “speculative grade” or high-yield bonds. Sometimes also called junk bonds, these bonds offer higher interest rates to attract investors and compensate for the higher level of risk.
The timing of a bond's cash flows is important. This includes the bond's term to maturity. If market participants believe that there is higher inflation on the horizon, interest rates and bond yields will rise (and prices will decrease) to compensate for the loss of the purchasing power of future cash flows.
Treasury yields can go up, sending bond prices lower, if the Federal Reserve increases its target for the federal funds rate (in other words, if it tightens monetary policy), or even if investors merely come to expect the fed funds rate to go up.
Effectively, this is because the current economic climate combines relatively low, stable inflation with high bond yields – in other words, bonds are cheap, offering decent returns, and these aren't likely to be decimated by runaway inflation in the near future.
Government bonds are selling off across the world, driving up yields as traders reassess U.S. inflation risks and monetary policy. Other countries tend to follow the U.S. due to its economic influence and the size of its debt markets.
Inflation is part of the explanation. In a world where consumer prices are rising quickly, investors demand higher bond yields both because they expect central banks' policy rates to stay higher for longer, and to compensate for the anticipated erosion of the principal's purchasing power.
Rising yields can create capital losses in the short term, but can set the stage for higher future returns. When interest rates are rising, you can purchase new bonds at higher yields. Over time the portfolio earns more income than it would have if interest rates had remained lower.
Junk Bonds
Junk bonds are high-yield corporate bonds issued by companies with lower credit ratings. Because of their higher risk of default, they offer higher interest rates, potentially providing returns over 10%. During economic growth periods, the risk of default decreases, making junk bonds particularly attractive.
An environment of elevated interest rates means investors need to be prepared for a period of volatility in stocks. A higher cost of capital than previously thought tends to undermine valuations in the growth sector and on consumer-discretionary names, as well as small- and midsized companies.
You can think of the bond yield as an investor's reward for lending their money to the government or a company by buying bonds. Because the bond market in the UK is so vast, valuing nearly £2.4 trillion as of June 2023, the yield can be useful to compare the attractiveness of potential bond investments.
Gilts are widely viewed as being among the safest type of bond. However, the interest rate, or yield, available from Gilts is usually quite low – as with all investments, to enjoy potentially higher returns, you need to take on more risk.
They are a good investment in 2024, experts say, for the same reasons they felt like a bad investment in 2022. That year, the Federal Reserve embarked on a dramatic campaign of interest-rate hikes in response to inflation, which reached a 40-year high.
For example, if you redeem a bond after 24 months, you'll only receive 21 months of interest. Depending on the interest rate of your bond and your own financial needs, it's generally beneficial to wait until full maturity to redeem them.
For the investor who has purchased the bond, the bond yield is a summary of the overall return that accounts for the remaining interest payments and principal they will receive, relative to the price of the bond. For an issuer of a bond, the bond yield reflects the annual cost of borrowing by issuing a new bond.
If an investor is looking for reliable income, now can be a good time to consider investment-grade bonds. If an investor is looking to diversify their portfolio, they should consider a medium-term investment-grade bond fund which could benefit if and when the Fed pivots from raising interest rates.
Municipal Bonds
Most bonds issued by government agencies are tax-exempt. This means interest on these bonds are excluded from gross income for federal tax purposes.
Rising inflation makes bonds less attractive, too, because it erodes their value. If a bond pays 4% interest, and inflation reaches 5%, then the bond's effective rate of return is negative. Even before 2022, bonds weren't doing all that well.
The easiest way to understand bond prices is to add a zero to the price quoted in the market. For example, if a bond is quoted at 99 in the market, the price is $990 for every $1,000 of face value and the bond is said to be trading at a discount.