Coming flood of U.S. Treasury issuance spooks some investors

Coming flood of U.S. Treasury issuance spooks some investors

Subject: Polity

Section: Federalism

Context:

• Cracks are forming in the market’s bullish consensus for bonds, as resurfacing fiscal concerns duel with expectations that cooling inflation will push the Federal Reserve to cut interest rates in coming months.

About Bonds

• A bond is a debt investment to raise money and finance a variety of projects and activities.
• Corporates or governments issue bonds directly to investors, instead of obtaining loans from a bank.
• The investor buys the bonds and loans money to the entity and in turn receives fixed interest.
• This is for a defined period of time (till maturity date) and a variable or fixed interest rate (coupon rate).

Bond prices, Bond yields and interest rates Linkages

Bond Price –

• Face value is the money amount the bond will be worth at its maturity.
• It is also the reference amount the bond issuer uses when calculating interest payments.
• The issuance price of a bond is typically set at par face value.
• But a bond’s price changes on a daily basis, just like that of any other publicly-traded security.
• The actual market price of a bond depends on various factors including:
  • the credit quality of the issuer
  • the length of time until expiration
  • the coupon rate compared to the general interest rate environment at the time

Interest rates – 

• The price of a bond primarily changes in response to changes in interest rates in the economy.
• For instance, say the investors get a better return in corporate bond either due to rise in their rate or due to fall in rate of government’s bond.
• This would make the corporate bond much more attractive.
• Investors in the market will bid up the price of the bond until it trades at a premium that equalizes the prevailing interest rate environment.

Bond Yield –

• In simple terms, yield is the amount of return that an investor will realize on a bond.
• If the investor holds the bond to maturity, s/he will be guaranteed to get the principal amount back plus the interest.
• However, a bond does not necessarily have to be held to maturity by the investors.
• Instead, investors may sell them for a higher or lower price to other investors.
• The bond prices and yields generally move in opposite directions.
• This is because, as a bond’s price increases, its yield to maturity falls.

What causes the rise in bond yields?

• The major factors affecting the yield are –
  • the monetary policy of the Central Banks, especially the course of interest rates
  • the fiscal position of the government
  • government’s borrowing programme
  • global markets, economy, and inflation
  • A fall in interest rates makes bond prices rise and bond yields fall and vice versa.
  • In short, a rise in bond yields means interest rates in the monetary system have fallen.
  • In other words, the returns for investors (those who invested in bonds and government securities) have declined.