What does it Mean for Bond Yield to go Down?

Last Updated: 11 Jul 2022

The increase or decrease in overall return from the bond is called the ‘yield.’ To understand why bond yield decreases, you need to be aware of the phenomenon that bond prices and bond yields have an inverse relationship: when one goes up, the other goes down.

When bond prices move lower (drop), bond yields move higher in return. Similarly, when a bond’s price moves higher (increases), its yield will move lower. Short-term results are more difficult to predict. But, you could expect the value of a bond with a specific term and interest rate to decrease as interest rates rise.

If you’re shopping for a bond with a specific term, it’s harder to predict what will happen if interest rates rise. You can expect the value of this bond to decrease, but the degree to which it decreases is less predictable than in the situation described above.

Let’s say you buy a five-year bond with a 3% yield two years before interest rates go up by 1%. The value of your bond would drop because it will be more difficult to find another five-year bond with as low an interest rate as yours. When rates are higher, new five-year bonds will have a higher yield than your old ones so investors won’t want them as much because they’ll be able to get better deals elsewhere.

Here’s another way of thinking about this. If interest rates go up, the return on a new bond is superior to that of an old bond. So investors will sell old bonds with low coupons and buy new bonds with high coupons.

This leads to a drop in the price of existing bonds, which is why there is an inverse relationship between bond prices and interest rates. The exact opposite happens when interest rates fall; existing bonds become more valuable as they have higher coupons than the newly issued bonds, so their prices rise.

Why does this happen? If investors think they can earn a better rate of return elsewhere, they will sell bonds to raise cash, causing their value to decrease.

Relation Between Bond Prices & Stock Prices

Bonds have an impact on the stock market because when bond prices fall, stock prices rise. The opposite is also true: when bond prices rise, stock prices tend to fall.

Because bonds are frequently regarded as safer than stocks, they compete with equities for investor cash. Bonds, on the other hand, typically provide lesser returns.

When the economy is doing well, stocks tend to fare well. When consumers make more purchases, corporations earn more money due to increased demand, and investors are more confident. When the economy is performing well, selling bonds and buying stocks is one of the best methods to beat inflation. Consumers spend less when the economy slows, company profits decrease, and stock prices fall. When this happens, investors prefer the security of guaranteed interest payments.

What does a bond’s yield tell investors?

A bond’s yield is the primary measure of investment profitability. It is, in a way, the annualised return that an investor gets from their debt investment.

Irrespective of the market price, face value or coupon of the security, investors would look at the yield before making a decision.

Rising yields indicate that the underlying security is falling in price. This shows the lack of market confidence in the asset. And what happens when bold yield goes down? The reverse applies to falling yields, which indicates a stronger fundamental value.