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Floodgates Open For Bonds


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What's going on?

Bonds around the world sold off sharply once again on Monday, dropping to prices not seen in Europe and the US for years.

What does this mean?

Bonds are supposedly selling off thanks to strengthening economies and, on a related note, rising inflation. Stronger economies make bonds relatively less attractive to investors than stocks because the value of stocks is fundamentally tied to companies’ profits, whereas bonds simply promise a fixed payout (so, when profits are going up, as they are now, stocks benefit more than bonds, all else equal).

A recent increase in the oil price has also made higher inflation far more likely (e.g. fuel costs will almost certainly go up, potentially raising the prices of other goods and services). Inflation is also bad for bonds because it erodes the future value of money (e.g. $20 buys less stuff as inflation increases) – and so a bond that promises fixed future payments becomes less attractive.

Why should I care?

For markets: We may be witnessing the end of a three-decade winning streak for bonds.

Although there have been some blips, bonds have gone up in value substantially since the 1980s. They’ve performed well for a number of reasons, not least the big slowdown in inflation over that time period. The result, for investors, has been that anything “bond-like”, i.e. capable of paying a regular income – like a high-dividend stock or even a property like your home – has shot up in value. A reversal of bond prices would mean less support for such investments.

For you personally: Borrowing money is getting more expensive.

As bond prices go down, the interest rates that they offer new investors go up (how does that work? Click here). Since the rates at which banks lend their money are largely based on the interest rates offered by bonds, regular folks looking to take out a mortgage or a loan are facing higher costs.

Originally posted as part of the Finimize daily email.

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