Question:
What is the impact of bond price and yield on stock market? In a US government bond auction, what is the implication of a better than expected result?
Steve from LouRidge Mountain
Answer:
Steve, the answer is not simple, so I will focus on the part of the answer that is current and directly answers the intent behind your question.
Currently, most analysts and investors look to the bond market for two key reasons. The bond market is an indicator of long-term interest rates and the willingness of investors to invest in U.S. debt. Both of these are important indicators of future overall market investment. Both of these indicators point to the directional flow of money.
For example, in our current state of ultra-high debt, if a bond auction does not go well, it might be a sign that investors are worried about the U.S. economy. On the other hand, it could simply mean investors are more interested in putting their money to work in another area, such as the stock market. You have to see the big picture to understand why the money flow changed.
Simply, when demand for bonds is high, the prices rise and the yields drop, and vice-versa. One counterintuitive but general conclusion here is that when the economy is doing well, and the stock markets are rising, demand for bonds decreases as investors seek higher returns elsewhere. Thus, it becomes a better time to invest in bonds, especially if one is looking for a low-risk investment with a specific return. Conversely, when the economy is doing poorly, as it was last fall, demand rises, prices rise, and yields drop as investors look for a safe place to park their money.
Perhaps, in our current ambiguous economic state, the most important reason to watch the bond market is to determine the relative faith of investors in our economic recovery. If U.S. bond auctions go well, it means investors still have faith in our ability to recover from our current economic recession. This is a good sign for the overall investment climate.
As to long-term interest rates … This complicated can-of-worms is too much to open here, but I will say that one important indicator of near-term economic growth is interest rates, or, liquidity, the ability of all manner of businesses to raise capital and the ability of consumers to borrow, say for buying a house. Currently, as an example, mortgage rates are low because of depressed bond rates, which were forced down because of Federal Reserve intervention. See, I told you this was complex.
Trade in the day; invest in your life …
