Investors in fixed income often think about the short-term trend in bond prices and yields – from week to week or even day to day. Many of them will try to lock in profits or limit losses during times when prices move impulsively. But it is important to remember that the long-term trend is the real driver of bond prices and yields.
To understand the long-term trend in bond prices and yields, we first need to look at the forces that drive them. Bonds are primarily bought by investors interested in a regular income stream with a low amount of risk. These investors tend to prefer a higher yield when making their decisions. In addition, bonds have the benefit of being able to be sold in the future for a price that is often higher than their purchase price.
As a result, when demand for bonds is increasing and investors are looking for higher yields, bond prices tend to increase and yields tend to decrease. As demand decreases, the opposite tends to happen. This affects both the short-term movements in bond prices and yields as well as the long-term trend.
The Federal Reserve’s monetary policy also plays a role in the long-term trend in bond prices and yields. When the Federal Reserve is increasing the money supply, this will put downward pressure on bond prices and upward pressure on yields. Similarly, when the Federal Reserve is decreasing the money supply, this will put upward pressure on bond prices and downward pressure on yields.
The long-term trend in bond prices and yields can also be affected by other macroeconomic factors, such as inflation, government spending, and investor sentiment. When these factors are trending in a particular direction, bond prices and yields will tend to move in the same direction.
Investors should always take the long-term trend in bond prices and yields into account when making their decisions. While short-term fluctuations can be difficult to predict, the long-term trend can be more reliable. By understanding how bond prices and yields are impacted by various economic factors, investors can make wise decisions and maximize their long-term returns.