The big news today is the announced release of up to 60 million barrels of oil from the Strategic Petroleum Reserves. The planned release will be 2 million barrels per day for thirty days. The immediate result of the announcement is a swift decline in the overall market and a large drop in the price of oil. This “out-of-the-blue” move points out, once again, on any given day, anything can happen to shape the market.
What is the meaning of bond prices and how do they affect the market?
The question I received above is simple enough, yet I have been thinking about it for some time. The reason for my long pondering is the bond market is huge, diversified, and extremely correlative to the market, so an easy answer is difficult. The reader might as well have asked, “What is the meaning of life and how does it affect living?” Okay, perhaps the reader’s question is not that profound, but it is still difficult to answer in the space I have here. Nevertheless …
The asset class of “bonds” stretches from the “safe” low-yield bonds backed by the U.S. Treasury to the more risky, high-yield bonds that corporations use to create debt. In between a host of other bonds exist that offer low and high yields and various levels of risk. The prices of each of these can influence specific, related markets, and some can powerfully influence the overall market. It is important to keep in mind bonds are fundamentally about debt.
For example, U.S. Treasury bond prices reflect the mindset of the investment community. Does it believe in the “good faith and credit” of the U.S.? When the U.S. Treasury auctions bonds (sells debt), interest determines price. Generally, if the price is high (lower yield), investors are buying the “safety net” the bonds provide. If the price is low (higher yield), investors are putting their money to work in riskier assets, such as equities or commodities. Again, this is a generality, but it is one way to view the relationship between bond prices and the overall market.
Another view of this is more technical but as relevant. Interest rates and the bond prices have an inverse relationship. When interest rates rise, bond prices fall and when interest rates fall, bond prices rise. One can easily see how this coupled with the generality above can influence the market. There are numerous other bonds and myriad other ways bond prices affect the overall market directly and indirectly. In fact, to give you an idea of how complex and influential this relationship is, consider the proposed legislation in the U.S. House of Representatives. At this point, it is not the price that impacts the market; it is the vehicle itself that matters.
A House of Representatives panel on Wednesday approved a bill designed to create a market for covered bonds, instruments that offer banks a way to raise money for new mortgages, while providing investors more options for highly rated securities.
I don’t think I did a good job here, but, as I said, the question is complex, and sometimes, my brain just does not have enough juice to get to the essence in such a tight space.
Trade in the day – Invest in your life …
