Bonds 101: An Essential Guide to The Bond market
This bond market blog will help you understand the bare essentials which are important in the global macro process. These basics are essential to carry out an analysis for yourself and to lend conviction to your trading decisions.
The words Bond market are enough to make many traders head for the hills and trade technicals alone. It’s easy to want to shut out the noise than can so often render the fundamentals difficult to grasp.
Over at the Fotis trading Academy, we find that the global macro understanding gives us our edge; it is the first part of our three step process. Technical analysis is the final step when the ducks are lined up and we are ready to pull the trigger.
Those of you who have experienced any of our webinars know what we look for: information relating to growth, inflation and interest rates. In this summer period we will be taking a closer look at Central Banks and their role in deciding policy and rates. We will look at the way those three factors are considered in their process.
There is another important strand which weaves its way through all the factors presenting to the market players – sentiment. How are the traders behaving? Are they taking risks or are they fearful? How is the relevant data affecting their decision making process? Risk-on and risk-off are the two contrasting environments. To assess what we are looking at in terms of sentiment we have to understand bonds and, more particular, Government bonds. There are lots of types -junk, corporate, government – all with the same idea: get investor’s money and pay them interest for the ‘loan’.
Except it doesn’t’ work like that now. We are in the age of negative yields (yields meaning interest rates paid to the holder of the bond). Government bonds, as many of you know, are in many instances under water. More than 40% of government bonds have negative yields which, in simple terms, means you owe the government money (for lending it to them) when the bond matures at a specified time. This is causing grave concerns among economists but also a trend of bond buying that underscores a search for safety rather than return. It’s fearful participants are looking for places to invest in case there is a global recession. Or – worse – a crash as we saw in 2008.
Here is the familiar German Yield on the 10 yr Bund, image courtesy of www.stockcharts.com
Quite a shock to see it dip into negative territory and not very optimistic when it’s still 10 years to maturity!
The second important fact is that yields (the rate) move inversely to the price of the bond. It is unnecessary to understand the mechanics, but here is an oversimplified explanation if you’re interested. If you buy a bond which matures in 10 years, and the rate goes up, no one would want yours with a lower yield. So the price of the bond comes down to the level at which it would be attractive. If the rate goes down, your bond becomes much more attractive so it is in more demand and the price of it will rise. It is just a case of supply and demand.
Here is the inverse relationship in chart form…the German 10yr bond itself;
All major economies have their own bonds
In the UK they call them Gilts (they used to have gold edges!)
The US call them treasuries;
In Germany as in the EZ they are Bunds.
In Switzerland even their 50 yr note has seen negative territory and that means a dim outlook for any growth. If you own that one, the Government has your money for 50 years and – as of today – you wouldn’t see a penny.
That is why Bonds is a sensitive barometer of safety plays. It’s also why we will continue to discuss and take a look each week in the Monday blog.
If you have any questions which you want to ask please post below. No question is a silly question, just a learning curve!
There are different maturity lengths such as 2yr, 5yr,10 yr, 25yr, 50yr. And then there is the spread. That will be the subject of another blog because that comparative between the different time lengths in one country holds some powerful clues as to the business cycle and if a recession is likely.
Since it’s summer time, the next question is, shaken or stirred? 🙂
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