Bond prices have dropped amid rising inflation fears while stocks remain robust. Indeed, the bond market has been volatile in recent months as investors have grappled with rising interest rates and concerns about a potential recession.
As of today, July 12, 2023, bond prices have decreased over the last three months. The yield on the benchmark 10-year U.S. Treasury note, which is a measure of the interest rate on long-term government debt, has risen from 2.3% at the end of April to 3.1% today. This means that the price of bonds has fallen since investors can now get a higher yield by investing in other assets, such as stocks.
The release of inflation data is soon to be released, and we know that Inflation data can have a significant impact on bond prices. When inflation is high, it erodes the purchasing power of bondholders, making their fixed-income payments worth less. This can lead to lower demand for bonds, which in turn drives down their prices. On the other hand, if inflation is low, it makes bonds more attractive to investors. This is because bonds offer a fixed rate of return, which can provide a hedge against the risk of inflation. As a result, bond prices tend to rise when inflation is low.
U.S. 10-Year Treasury Bond Yield
Source: Financial Times
So far, inflation has been heading downward since the Federal Reserve started hiking interest rates. As a result, bond prices declined. As we can see in the data, the continuous increase in interest rates coincides with the consistent rise in the U.S. 10-year Treasury bond yields since May 15. When bond yield increases, their prices fall.
The relationship between inflation and bond prices is not always direct, however. For example, if inflation is high, but the economy is also growing strongly, bond prices may still rise. This is because investors may be willing to accept lower yields in exchange for the security of owning a bond. If inflation was low and interest rates were also low, then bond prices would have skyrocketed as the economy would have been growing rapidly. The U.S. economy is growing, but currently at a slower pace than in the pre-COVID period due to a tight credit market. Thus, bond prices ought to fall and their yield rise.
The impact of inflation data on bond prices also depends on the maturity of the bond. Bonds with longer maturities are more sensitive to changes in inflation expectations because they will have to make more interest payments over a longer period of time. As a result, bond prices with longer maturities tend to be more volatile when inflation data is released.
There are growing concerns that the U.S. economy could be headed for a recession. If a recession does occur, it would likely lead to lower demand for bonds, which would also put downward pressure on bond prices. As a result of these factors, bond prices have fallen sharply in recent months.
The pace of economic growth matters a great deal as well in the bond market. If economic growth slows more than expected, it could lead to lower demand for bonds and further declines in bond prices.
The impact of inflation data on bond prices can vary depending on the type of bond. For example, inflation-protected bonds (also known as TIPS) are designed to protect investors from the effects of inflation. As a result, TIPS prices tend to be less volatile than other types of bonds when inflation data is released.