Why when Bond prices go up, Yield (interest rates) goes down

[Dennis Ng]

Hi louiskst,

hope this will make it clear to you. Bonds are called Fixed Income Securities, ie. interest rates were fixed at issuance. So when demand for a bond increases, price goes up, and when price goes up, of course the original Interest divided by a higher price would lead to Lower Yield.

eg. 3% bond issued at US$100, or US$3 interest. When prices goes to US$110, US$3 interest divided by US$110 higher price, lead to lower yield. 2.7% instead.

The same applies for Properties as well. If rental income is S$50,000 a year, and price is S$1 million, Gross rental yield is 5%. If price goes up to S$1.2 million, rental yield falls to 4.17%.

Cheers!

Dennis Ng

Hi Dennis,

I am a bit confuse about operation twist. If US government trade shorter-dated bonds for longer dated bonds. The demand for longer-dated bond exceed the supply. This will increase the bond price. But why the interest rate will become lower? In my opinion, when there are more demand for bond ( which mean US goverment want to borrow more money), shouldn't the interest rate become higher? Since the money lenders is less than the money borrowers, the money lenders should be able to push the interest rate upward.

Sorry for all layman terms as I think this will be easier to understand.

Thanks.

[relaxman]

Hi Dennis,

Last week when I read your book, I also can't really understand 'why when bond price goes up Yield goes down'. Now I FULLY understand with your simple and easy illustration.

Thank you very much.

[louiskst]

Hi Dennis,

Thanks for your fast respond. I am clear now.

[ngtfook]

This SGX video will help you to understand about Fix Income Investment and Yield.

http://www.youtube.com/watch?v=FZ7HkDTtDok

Hi Dennis,

Last week when I read your book, I also can't really understand 'why when bond price goes up Yield goes down'. Now I FULLY understand with your simple and easy illustration.

Thank you very much.

[Dennis Ng]

Hi Dennis,

Last week when I read your book, I also can't really understand 'why when bond price goes up Yield goes down'. Now I FULLY understand with your simple and easy illustration.

Thank you very much.

Thus, one of my main fear is with countries continue to print money, prices would go up (ie. inflation rate goes up).

Currently, inflation rate in U.S. is about 2%, while 10 year U.S. government bond yield also about 2% (but recently has gone up to 2.35%)...if inflation in U.S. goes up to 4%, and if bond yield were to go up to 4% (ie. bond prices Need to fall for this to be achieved)...

Then how much would bond prices fall? Answer is 50%! Which means that bond market would Crash!

Currently, U.S. government Bond is the ONLY safe haven asset that the world really knows, believes in and invest in. So when bond market crash, one can imagine what panic it can create...

Which is why I say that Bond market is the Last and Ultimate bubble to be burst!

28 Dec 2011:

The shifting of Bubble since year 2000 and why the Ultimate Bubble likely to burst in year 2012...

Let's go back in time:

1. In Mar 2000, the Technology bubble burst. Nasdaq crashed from over 5,000 points to 1,200 points by end of year 2001.

2. U.S. was in danger of slipping into recession. Alan Greenspan "came to the rescue" and cut interest rates from 6% to as low as 1% by year 2003...he held interest rates at 1% till year 2004...

3. this fuelled the Property Bubble in U.S. and the extreme scenario whereby banks were lending 100% financing (NO cash needed to purchase house) for Sup-prime Credit (people with credit problem, or insufficient income or have problem repaying loans) at low interest rates...

4. This led to an extreme increase in demand for properties (which was unsustainable becos it was extreme) and property prices went up and up from year 2003 to year 2006...

5. Property prices in U.S. peaked in year 2006, started falling in year 2007, but the sub-prime Crisis only ballooned and exploded in year 2008...

6. On 15 Sep 2008, Lehman Brothers (4th largest investment bank in the world) collapsed, that trigger a massive Freeze in liquidity in Global financial markets and even once strong and formidable financial institutions such as JP Morgan & Chase, CITIGROUP and Goldman Sachs needs to be rescued to avoid collapse.

7. The U.S. government poured over US$1 trillion to rescue the U.S. Financial Sector...but the rescue money (even Goldman Sachs received US$10 billion) did NOT flow back into U.S. economy...this is why nearly 3 years after the Global Financial Crisis in year 2008, U.S. economy is still NOT recovering and unemployment remains high at 8.6%.

8. The U.S. financial institutions used the money to speculate in markets to make money....Stock markets throughout the world went up by over 100% from Crisis lows, Commodity markets such as Gold and Silver went up by over 100% as well....even property markets in Asia got a "viagra boost'...

9. All parties come to an end...in the last few months, global liquidity begins to sell of "Risky Assets", basically everything except Risk Free Assets....and the No. 1 Risk Free Asset the whole world knows is called U.S. government bonds.

10. now the bubble has shifted to U.S. government bonds. 10 year U.S. government bonds at 2% yield is at historical Lowest Yield (lowest interest rates) or in other words, U.S. government bonds at Historical HIGHEST Price...

11. the odds are interest rates might be forced to rise in U.S. when inflation goes up, and when that happens, U.S. bond prices would fall.

With 10 year bond at 2%, if inflation goes up to 3% and if yield goes up to 3%, means U.S. bond prices would fall by 33%.

If inflation goes up to 4% and yield goes up to 4%, means U.S. bond prices would fall by 50%...

12. So the Last and ULTIMATE Bubble is U.S. government bonds. Most countries in the world hold at least 1/3 of their wealth in U.S. government bonds. eg. China has US$3 trillion, and US$1.13 trillion (China has sold about US$400 billion bonds in last few months) is in U.S. government bonds, even Singapore holds US$63.7 billion...

Below link shows MAJOR FOREIGN HOLDERS OF TREASURY SECURITIES:

http://www.treasury.gov/resource-center ... ts/mfh.txt

13. So when U.S. government bonds Crash, likely to happen in year 2012, many countries would be losing a BIG Portion of their Wealth...

14. So last few months investors have been selling other investments eg. stocks, commodities and all ESCAPING and running to buy U.S. government bonds, this lead to the strengthening of the U.S. Dollar and the historical lowest yield on U.S. government bonds...guess what will happen to confidence in Global Financial Markets when this ONLY last known "Safe Haven" is found to be unsafe?

15. Global Financial Crisis would hit, and this would be the worst Global Financial Crisis since 1929 Great Depression and likely to last much longer and deeper than the previous Crisis in year 2008...

[Dennis Ng]

not sure if anyone notice, but recently there's been some selling off of U.S. government bonds. 10 year U.S. government bond yield went from the low of 1.8% a few months ago to about 2.35% currently. While 30 year U.S. government bond yield went up from about 3% to about 3.46% currently.

Actually, in another posting in this forum about 2 months ago, I also said that please monitor 30 year U.S. government bond yield, if it goes up, it might shows that investors are selling off some risk free asset (U.S. bonds) and to take on risk (buy Risk assets) such as stocks.

Of course, rise in yield can also be partly caused by concern of higher inflation caused by higher oil prices.

So U.S. can try to keep interest rates low, but if inflation rate rises, people would sell off bonds and leading to rise in bond yield, and U.S. may be forced to offer higher interest on new bonds to be issued to replace bonds reaching maturity dates...so interest rates might go up even if it's U.S government, including Fed's Bernanke's wish for interest rates to stay low till year 2014.

Man proposes, heaven disposes.

[Dennis Ng]

Hi Dennis,

Indeed I check on the Bloomberg website and 30 year US Bonds is offering 3.46% yield now.

rise in yield can also be partly caused by concern of higher inflation caused by higher oil prices.

Am I right to say that if there is higher inflation *(say above 3%), people will not find it worthwhile to put their money in bonds. Hence they are likely to sell them off, which is why bonds prices will fall. When that happens, bond yields increases/rise.

And in order to attract buyers to new bonds, US govt needs to offer higher interest rate say 4% or 5% to attract those funds to invest in bonds. Then bond yields will fall. So is the issuance of new bonds linked to the US economy health? I mean if US economy improves, is there likelihood that US Govt will sell less 30 year bonds?

Hi jfoo2,
nope, if U.S. issue 30 year bonds at higher interest rates, this is likely to lead to higher interest rates in general. And if interest rate rises, and with inflation higher, (cost of general goods and services) higher, then Americans have to pay more in Housing Loan instalments (Mortgages) and petrol...which might lead to them spending less on consumption...which is bad for U.S. economy since 70% of U.S. economy comes from Internal Consumption by Americans.

So when that happens, U.S. economy might also slow down as well, which will then be bad news for stock markets, since companies would be having higher costs (inflation and higher interest payments) and thus likely to face lower profits (lower sales).

Look at Greece, a country in Financial Trouble. Its bond yield went from 4% to now 17.5% (after more than 50% of bond written off as bad debt)...bond yield was over 30% before the debt write-off.

Historical chart of U.S 30 year bonds provided free by yahoo finance:
http://sg.finance.yahoo.com/echarts?s=^ ... X;range=my

If we look at the historical chart of U.S. 30 year government bonds. It is quite clearly that now Yield is at the HISTORICAL lowest level, which also means that Bond prices are at its HISTORICAL Highest Level. Market tend to revert to the mean, and if mean reversion happens, means that Bond prices are likely to fall and Bond yields are likely to rise.

Investing is about assessing what is more likely to happen and to position ourselves accordingly. Of course, we can be wrong, and in fact, one can afford to be wrong 6 out of 10 times and still become richer by using the investment rule of only investing when Upside is at least double Downside...

Actually, I rather be wrong that a Bubble in Bonds is formed and likely to burst (just a matter of time)...becos if I'm right, many people would lose most of their wealth as they would NOT be prepared for the Financial Avalanche that would follow a Crash in U.S. government bonds.