Sharply higher rates, however, suggest the market thinks that keeping short-term rates low will only amplify inflationary effects in the future. Now the bond market is testing that, but the central banks don’t want to blink. To instil confidence among borrowers, central banks committed to not raise interest rates until there was clear evidence of higher inflation. That is due in part to vaccines, to government spending packages and to central banks’ willingness to keep short-term interest rates low. The main reason they’re rising is because the market is anticipating that the economy will emerge from its pandemic slump far quicker and more robustly than previously anticipated. When bond rates are low, the cost of waiting for those profits to come is low. The other reason is that many tech companies aren’t profitable (yet) so the market is valuing their ability to make money well into the future. The first is that low bond rates imply low growth for the economy, which in turn forces investors to pay more for companies that are growing by other means, such as a disruptive product. When bond rates rise, tech stocks tend to get hurt. If an investor is buying shares in the major banks because they have a dividend yield of say 5 per cent, that yield is more attractive when the bond rate is 1 per cent and less attractive when the yield is 7 per cent.Ĭounter-intuitively, bond rates have the biggest influence on high-growth technology stocks. If the three-year bond rate is 1 per cent, it makes little sense to accept a similar rate for a three-year loan to a risky corporation at the same rate. A steep yield curve describes a market where long-term rates are high relative to short-term rates. The yield curve is a plot of the rates for different maturities.The credit spread is between the government bond rate and a particular state or corporate bond and is a measure of the additional risk. Common spreads are the difference between the US and Australian 10-year rate, the difference between the two-year rate and the 10-year rate. The spread refers to any difference in rates from one bond to another.The longer the maturity, the more sensitive the bond price is to moves in yields. This reflects the fact that previous owners bought at a time when rates were lower and need to drop their price if the market rate is higher. But it is important to remember that when the yield goes up, the price goes down (and vice versa). The price of the actual bond is hardly ever referenced as traders tend to focus on the yield as a measure of price.Typically, the longer the maturity is, the higher the yield, as investors want to get paid a higher rate for lending for a longer term. The maturity is the length of time until the bond is due to be repaid.The Australian 10-year bond rate is around 1.61 per cent.
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