In the country’s financial markets, the intricate balance between bond prices and yields has taken centre stage as policymakers, long-term investors, and savers evaluate their responses to interest rate movements due to both domestic and international geopolitical developments.
The benchmark 10-year government bond yields climbed to 6.55% this week. Such a move makes it imperative to carefully understand the ongoing developments in the bond markets, as it will be vital for those seeking to navigate today’s environment.
Understanding and acknowledging the inverse relationship
Bond prices and yields always move in opposite directions. This is a fact driven by the fixed coupon structure that bonds carry. Furthermore, as yields rise in the broader market, the prices of older bonds that have lower coupon rates fall to align with newer bonds, providing better returns.
Why do older bonds lose value?
- Older bonds with lower coupons become less lucrative when new bonds offering higher yields become available.
- Investors in such cases demand discounts on older bonds to ensure matching prevailing market yields.
- The adjustments in prices ensure that older bonds continue to remain competitive for buyers.
- This also helps in sustaining liquidity in the secondary market and keeps the bond market flowing.
Interest rate moves impact every bondholder
The policy decisions of central banks exert a powerful influence on bondholders. In the US, these decisions are governed by the Federal Reserve where whereas in India, these decisions are governed by the Reserve Bank of India by repo rate decisions, open market operations, and forward guidance, which cumulatively impact bond yields.
Recent data shows the 10-year government bond yield is up by 0.23 percentage points in the last four weeks, reflecting the impact of both global cues and domestic fiscal outlook.
- Yield volatility increases during policy updates and changes.
- Market participants, global investors keenly follow inflation and fiscal stimulus cues.
- Every rate hike or cut echoes across the sovereign and corporate bond landscape.
- RBI’s liquidity steps, like Cash Reserve Ratio (CRR) tweaks or borrowing plans, directly sway bond yields.
Implications for fixed income investors
Falling bond prices impact portfolios, especially those with longer maturities. Prudent investors are increasingly rebalancing their allocations in response to shifting yield curves and fiscal interventions. The goal in such cases should be to speak to bond market professionals or qualified financial advisors for proper guidance on such technical issues before going ahead with any investment decisions.
Key takeaways
- Bond prices fall when market yields rise.
- Interest rate changes influence bonds and their attractiveness as investment tools.
- Policy shifts drive yield volatility. That is why one should pay attention to fiscal decisions.
- Longer maturity bonds face sharper price swings. That is why they are riskier.
- Competitive pricing ensures market liquidity and keeps the bond market lucrative.
Disclaimer: This article is for informational purposes only and should not be construed as investment advice. Readers are advised to consult certified financial advisors before making any investment decisions.
