Please explain a bond rally as if I'm a 3yr old

[Unionville]

I don't understand the concept of a 'bond rally'.  Let me give you an example:

Let's say I buy a 5 year bond at 5%. No matter what's going on in the stock or bond world, I can ignore it, because it has no effect on my getting my 5% return.

So when people say 'bond rally', does it mean a bunch of new bonds are available for 6%?  Or are people shuffling papers under the table to jump ship on their bond commitment  in order to trade with others to haggle for 6%? I don't understand how a bond can rally since the whole point of a bond is you keep and hold it.

If I'm happy with my 5%, why should it matter what someone else is getting? To me, the good thing about bonds (vs stocks) is you can block out all the noise, and just have a cup of tea.

[secondcor521]

Usually it means the prices of bonds in general are going up.

Usually that's because people want to own bonds more than they want to own other things.  So they sell the other things and buy bonds.

That's usually because bonds are perceived as safer investments and the world is a scary place sometimes.  Sometimes it can be because bonds are paying a relatively high interest rate (where "high" is defined as "higher than stocks" or "higher than they usually are").  Sometimes it's both.

[Alternatepriorities]

I'll take a stab at this though I'm no expert and don't own any bonds currently...

Basically the rally or crash all comes down to the people who for one reason or another can't hold their bonds until maturity. Last week saw a perfect example of this with the bank runs. When customers started drawing more money out of their bank accounts than the banks had on hand in cash or in securities that were maturing in time the banks were forced to sell some of their longer term bonds to other investors to raise cash. Since you can go out and buy a brand new T-bill paying something like 4.5% right now no one will want to pay face value for the bonds the bank bought two years ago that pay 1%. So the buyer will demand a discount that makes the old bond have the same value as the current offerings with the same risk. This forced the banks in question to take a significant loss and in a couple of cases now it was enough the bank fell.

If this banking chaos forces the fed to start lowering rates, then when new bonds start coming out at 3% this years bonds that pay 4.5% will command a premium resulting in a bond rally.
 

[ender]

I don't understand how a bond can rally since the whole point of a bond is you keep and hold it.

This assumption is incorrect.

Organizations buy/sell bonds all the time. In addition to paying money out they can grow (or decrease) in value and effectively be bought/sold.

I'll take a stab at this though I'm no expert and don't own any bonds currently...

Basically the rally or crash all comes down to the people who for one reason or another can't hold their bonds until maturity. Last week saw a perfect example of this with the bank runs. When customers started drawing more money out of their bank accounts than the banks had on hand in cash or in securities that were maturing in time the banks were forced to sell some of their longer term bonds to other investors to raise cash. Since you can go out and buy a brand new T-bill paying something like 4.5% right now no one will want to pay face value for the bonds the bank bought two years ago that pay 1%. So the buyer will demand a discount that makes the old bond have the same value as the current offerings with the same risk. This forced the banks in question to take a significant loss and in a couple of cases now it was enough the bank fell.

If this banking chaos forces the fed to start lowering rates, then when new bonds start coming out at 3% this years bonds that pay 4.5% will command a premium resulting in a bond rally.
 

Yep.

A good question to the OP: if you bought bonds at 1% years ago, would you want to lock up your cash in them still? Why/why not? The answer will largely dictate why the bond market can exist.

[vand]

Bomds are issued on a primary market but traded on a secondary market (ie an exchange) where they are marked to market. 

If new bonds are issued paying 5% then your 3% bonds are repriced to move in line with that.

[MustacheAndaHalf]

I don't understand the concept of a 'bond rally'.  Let me give you an example:

Let's say I buy a 5 year bond at 5%. No matter what's going on in the stock or bond world, I can ignore it, because it has no effect on my getting my 5% return.

So when people say 'bond rally', does it mean a bunch of new bonds are available for 6%?

To a child: "Your bonds are too small.  Everyone wants big bonds, not yours.  You lose."

Assuming a $10,000 bond, a "5 year bond at 5%" pays $500/year for 5 years, paying you a total of $12,500 to you over 5 years.  If "new bonds are available for 6%", those pay $600/year for 5 years, so you'll get repaid $13,000 over that time.

Everyone likes $13,000 more than $12,500.  They want 30% over 5 years.  What to do?

Sell your $10,000 bond for the discount price of $9,600.  The person buying it still gets $12,500 at the end... which is now 30% more than the $9,600 they paid.  Now they don't care if they pay $9600 and get 30% or pay $10,000 and get 30%.

I have rounded off the numbers and ignored complex time value considerations (the $500 vs $600 annual interest), but that's the basic idea.

[GilesMM]

A bond rally refers to a period of time in which the price of bonds rises significantly. When bond prices increase, the yield or interest rate on those bonds decreases. This means that investors are willing to pay more for the same amount of interest, indicating increased demand for the bonds.

There are several factors that can cause a bond rally. One possible reason is an overall decrease in interest rates in the economy. When interest rates fall, investors may shift their investments from other types of assets, such as stocks or real estate, to bonds. This increased demand for bonds can drive up prices and lead to a bond rally.

Another factor that can contribute to a bond rally is increased uncertainty in the economy. When investors are worried about market volatility or geopolitical events, they may seek out safe-haven assets such as bonds. This increased demand can also lead to higher bond prices and lower yields.

Overall, a bond rally is characterized by rising bond prices and lower yields. This can be beneficial for investors who hold bonds, as they may see an increase in the value of their investments. However, it can also make it more difficult for investors to find high-yielding bonds, as yields tend to fall during a rally.

[chasesfish]

Your 5% bond is worth more in a bond rally.  People will pay you more than you paid because interest rates went down.

[Finances_With_Purpose]

Usually it means the prices of bonds in general are going up.

Usually that's because people want to own bonds more than they want to own other things.  So they sell the other things and buy bonds.

That's usually because bonds are perceived as safer investments and the world is a scary place sometimes.  Sometimes it can be because bonds are paying a relatively high interest rate (where "high" is defined as "higher than stocks" or "higher than they usually are").  Sometimes it's both.

This. 

You may not sell your bonds, but many people, and especially institutions, do.  All it means is that people want bonds more than other things. 

[MustacheAndaHalf]

I don't understand the concept of a 'bond rally'.  Let me give you an example:

Let's say I buy a 5 year bond at 5%. No matter what's going on in the stock or bond world, I can ignore it, because it has no effect on my getting my 5% return.

So when people say 'bond rally', does it mean a bunch of new bonds are available for 6%?

...

Your 5% bond is worth more in a bond rally.  People will pay you more than you paid because interest rates went down.

Per original post (above), the examples are rising rates like 2022 and (so far) 2023.

[AJDZee]

If you have time, watch this Rob Berger clip on the basics


https://www.youtube.com/watch?v=kPTdUZpBlj8&t=186s

[Babybalrog]

3yr old

"Bond are issued on a primary market but traded on a secondary market. A rally happens on the secondary market when the price goes up. We don't have to participate if we don't want to, and can hold until the bond matures."

The great things about bonds if you always have that choice. With stocks there is only one exit strategy. Sell to another person. This leads to what is known as "Greater Fool Theory"

Not all bonds are bought and held for their entire duration by the same person. I would say, almost all are traded at some point. Many businesses by bonds short term to earn some yield on their cash. At one point Apple had so many bonds they eclipsed the largest bond fund in the world. That's just so they can earn a few % on their money instead of zero at the bank. Others like banks and insurance companies use it for risk management.