Why Does a Rising Yield Mean a Falling Price? Two Views of One Thing

A bond promises a fixed series of payments, typically a stated amount each year and the face value returned at the end, and those promises do not change once the bond exists. If the market price of that bond falls, a buyer pays less for exactly the same stream of payments, so the return earned on the money invested rises. If the price rises, the same payments cost more and the return falls. The two are therefore the same fact expressed in different units, which is why reporting a yield rise and a price fall are two descriptions of one event rather than two things happening.

Several forces push bond prices around continuously:

• •Central bank interest rates, since newly issued bonds pay whatever rates require
• •Expected inflation, which erodes the value of fixed future payments
• •Perceived risk that the issuer will not pay, which is where credit ratings enter
• •How long until the bond matures, with longer bonds moving far more
• •Demand from institutions obliged to hold particular kinds of debt
• •Flight to safety during crises, which raises prices of the safest government bonds

Plotting yields against time to maturity gives a curve that is watched intensely, because its shape carries information about expectations. Normally longer bonds yield more than shorter ones, compensating holders for tying money up and for the greater uncertainty over a longer horizon. When short-term yields exceed long-term ones the curve is described as inverted, which indicates that markets expect interest rates to be lower in future, which in turn usually means they expect economic weakness. That inversion has preceded most recessions in recent decades, which has made it among the most closely followed indicators in finance, and it has also produced several false signals, so it is a warning rather than a forecast.

Two bonds paying the same rate but maturing at different dates respond quite differently to the same change in market rates, and the reason is worth following. A bond maturing next year returns its face value almost immediately, so a change in prevailing rates affects only one small payment before the holder gets the money back and can reinvest at whatever the new rate is. A bond maturing in thirty years locks the holder into the old rate for three decades, so the same change in rates affects thirty payments and the price must move far more to compensate. That sensitivity is measured as duration, and it explains why long-dated government debt swings violently while short-dated debt barely moves.

Government bond yields determine what a state pays to borrow, which feeds directly into budgets and therefore into policy. A rise of one percentage point across a large national debt adds enormous sums to annual interest costs, crowding out other spending. Those yields also anchor borrowing costs throughout the economy, since mortgages, corporate debt and business lending are priced relative to government debt of comparable duration, so a movement in one propagates everywhere. Pension funds and insurers holding long-dated bonds see the value of their assets and their obligations move together in ways that can force sudden selling, which was the mechanism behind the British market disruption of September 2022.

A bond's payments are fixed at issue, so a lower price buys the same stream more cheaply and the return rises, which makes price and yield two descriptions of one fact. Central bank rates, expected inflation, perceived default risk and time to maturity move the price. An inverted curve indicates markets expect lower rates ahead and has preceded most recent recessions. Government yields anchor borrowing costs throughout the economy.