Struggling to understand the recent uptick in bond prices

[Mr. Green]

Back in early February I switched 75% of our bond allocation from Total Bond Market to short-term TIPS.  Until a couple weeks ago, it looks like I saved myself a 10% drop in BND. However, Total Bond Market has rallied in recent weeks and I'm struggling to understand why. The inflation data released today shows it is not abating yet and the Fed will need to continue to raise interest rates. Wouldn't the expectation of continually rising interest rates cause bond prices to continue falling? Are they up because the increased risk/fear of a recession and the corresponding money moving into bonds is outweighing the risk of poorer yields for longer because of rising interest rates? Bonds are admittedly my weekest subject.

Secondarily, and I know mortgage rates are linked, I'm wondering why the big drop in mortgage rates/10-year treasury rates? I would think the expectation of continued interest rate hikes would have the same effect here but in the last week mortgage rates dropped almost half a point. I'm scratching my head.

[dividendman]

I think the gist of it is that a recession is coming and rates will have to go lower early next year... who knows if that's going to be the case though.

[PDXTabs]

I too struggle to understand the bond market. But don't forget that these bonds are traded on the world market and right now US bonds are yielding more than UK, German, Japaneses, Chinese, French, or Spanish ones: https://www.wsj.com/market-data/bonds

[Financial.Velociraptor]

I too struggle to understand the bond market. But don't forget that these bonds are traded on the world market and right now US bonds are yielding more than UK, German, Japaneses, Chinese, French, or Spanish ones: https://www.wsj.com/market-data/bonds

A huge part of the demand for US Treasuries is driven by expectations for the strength of the dollar against other currencies.  The Fed committing to fighting inflation and squashing inflation is bullish for the dollar.  The 10 year Treasury is sort of the benchmark for the pricing of all other dollar denominated bonds.

At the same time, the trade imbalance is widening.  We buy more foreign goods and services with US Dollars.  The dollars are no use in the foreign country and must be used to buy American goods/service or American assets.  The 10 year T is sort of the default, especially for foreign central bank currency reserves.

[cool7hand]

I too struggle to understand the bond market. But don't forget that these bonds are traded on the world market and right now US bonds are yielding more than UK, German, Japaneses, Chinese, French, or Spanish ones: https://www.wsj.com/market-data/bonds

A huge part of the demand for US Treasuries is driven by expectations for the strength of the dollar against other currencies.  The Fed committing to fighting inflation and squashing inflation is bullish for the dollar.  The 10 year Treasury is sort of the benchmark for the pricing of all other dollar denominated bonds.

At the same time, the trade imbalance is widening.  We buy more foreign goods and services with US Dollars. The dollars are no use in the foreign country and must be used to buy American goods/service or American assets. The 10 year T is sort of the default, especially for foreign central bank currency reserves.

Hi @Financial.Velociraptor. Could you explain the bolded text some more? Why can't the recipient just convert US currency to the local currency? I'm not understanding how this is connected to US bond price. It's probably one of those nuanced or counterintuitive points one might need a little more foundation to understand. Thanks!

[MustacheAndaHalf]

I'm happily out of touch with markets for another month or so, so this will be out of date.  In short, part of the market fears a deep recession, so their prediction is for much lower bond yields, which pushes current bond values higher.  I think Goldman Sacs compared the situation to a "hurricane" on the horizon, and they backed up their belief by keeping their stock dividend unchanged while other banks increased theirs.

Besides the "deep recession" camp, there's "mild recession" and "soft landing" views of the market, each represented in stock & bond prices.  Some think the Fed will cause a recession, but it will be mild (based on strength of the consumer & savings).  In the Fed can pull off a "soft landing", bond yields would be stable, going up with Fed funds rate increases, and then back down when inflation falls.

I don't understand the drop in mortgage prices you mentioned, but I don't follow them at all.  On CNBC's Halftime Report I heard Josh Brown say new housing starts "fell off a cliff" a day or so ago - which is the only financial news I've watched in a week.  If demand for mortgages is falling, banks might be competing on price.  I don't know how far that can go - each Fed meeting pushes up the Fed funds rate, which I expect drives up mortgage rates.

[ChpBstrd]

Record inflation is the current news, but the people pricing bonds with 5-10 years duration remaining on them are looking beyond the next few months of rate hikes, beyond the recession, and weighting the expected value of today's yields in 2024-2032. By this time next year, we will likely have already had a recession and rate cuts will be occurring. Some market participants are thinking "this is my chance to lock in yield before the SHTF and the Fed is forced to cut rates".

Remember, CORE CPI was actually down slightly in June, despite rising commodity and energy prices. What will July CPI look like now that commodities have collapsed? Various market participants are calling peak inflation, and the bottom in bonds, every day. Just like with the stock market.

[LightStache]

It was mid-June when the data became clear that the economy was seriously deteriorating and the rhetoric from the Fed shifted.

That cooling of the economy should act to depress inflation in the mid term, implying lower interest rates for that time horizon.

As a result we're seeing a significant inversion of the yield curve with 1 year treasuries at 3.2%, the 5 year at 3.0%, 10 year at 2.9% and the 30 year at 3.1%. Other fixed income products, like mortgages, follow the same trends.

Of course all of this pricing assumes that a recession will reduce demand and cool inflation. That's what recessions normally do. The trillion dollar question is whether we're starting a sustained period of stagflation in which case this four week rally will likely be reversed and we'll see fixed income prices fall much further.

[Financial.Velociraptor]

I too struggle to understand the bond market. But don't forget that these bonds are traded on the world market and right now US bonds are yielding more than UK, German, Japaneses, Chinese, French, or Spanish ones: https://www.wsj.com/market-data/bonds

A huge part of the demand for US Treasuries is driven by expectations for the strength of the dollar against other currencies.  The Fed committing to fighting inflation and squashing inflation is bullish for the dollar.  The 10 year Treasury is sort of the benchmark for the pricing of all other dollar denominated bonds.

At the same time, the trade imbalance is widening.  We buy more foreign goods and services with US Dollars. The dollars are no use in the foreign country and must be used to buy American goods/service or American assets. The 10 year T is sort of the default, especially for foreign central bank currency reserves.

Hi @Financial.Velociraptor. Could you explain the bolded text some more? Why can't the recipient just convert US currency to the local currency? I'm not understanding how this is connected to US bond price. It's probably one of those nuanced or counterintuitive points one might need a little more foundation to understand. Thanks!

Bro!  You can totally change your Dollars for local currency.  But only to someone who actually needs/wants USD.   You only want USD if you intend to buy US goods/services OR US assets.   The default US asset is the 10 year Treasury.  Ultimately, USD can only be spent in the US.

[Mr. Green]

I too struggle to understand the bond market. But don't forget that these bonds are traded on the world market and right now US bonds are yielding more than UK, German, Japaneses, Chinese, French, or Spanish ones: https://www.wsj.com/market-data/bonds

A huge part of the demand for US Treasuries is driven by expectations for the strength of the dollar against other currencies.  The Fed committing to fighting inflation and squashing inflation is bullish for the dollar.  The 10 year Treasury is sort of the benchmark for the pricing of all other dollar denominated bonds.

At the same time, the trade imbalance is widening.  We buy more foreign goods and services with US Dollars. The dollars are no use in the foreign country and must be used to buy American goods/service or American assets. The 10 year T is sort of the default, especially for foreign central bank currency reserves.

Hi @Financial.Velociraptor. Could you explain the bolded text some more? Why can't the recipient just convert US currency to the local currency? I'm not understanding how this is connected to US bond price. It's probably one of those nuanced or counterintuitive points one might need a little more foundation to understand. Thanks!

Bro!  You can totally change your Dollars for local currency.  But only to someone who actually needs/wants USD.   You only want USD if you intend to buy US goods/services OR US assets.   The default US asset is the 10 year Treasury.  Ultimately, USD can only be spent in the US.

And a good bit of the Caribbean where the dollar has become the de facto currency because of US tourism. ;)

[ChpBstrd]

I too struggle to understand the bond market. But don't forget that these bonds are traded on the world market and right now US bonds are yielding more than UK, German, Japaneses, Chinese, French, or Spanish ones: https://www.wsj.com/market-data/bonds

A huge part of the demand for US Treasuries is driven by expectations for the strength of the dollar against other currencies.  The Fed committing to fighting inflation and squashing inflation is bullish for the dollar.  The 10 year Treasury is sort of the benchmark for the pricing of all other dollar denominated bonds.

At the same time, the trade imbalance is widening.  We buy more foreign goods and services with US Dollars. The dollars are no use in the foreign country and must be used to buy American goods/service or American assets. The 10 year T is sort of the default, especially for foreign central bank currency reserves.

Hi @Financial.Velociraptor. Could you explain the bolded text some more? Why can't the recipient just convert US currency to the local currency? I'm not understanding how this is connected to US bond price. It's probably one of those nuanced or counterintuitive points one might need a little more foundation to understand. Thanks!

Bro!  You can totally change your Dollars for local currency.  But only to someone who actually needs/wants USD.   You only want USD if you intend to buy US goods/services OR US assets.   The default US asset is the 10 year Treasury.  Ultimately, USD can only be spent in the US.

My answer would be that, yes, you can trade it for local currency, but any dollar buyer who is willing to make that trade with you is doing so because they want to spend the USD on something priced in USD. Maybe that's a vacation to New York City? Maybe that's a tanker load of Saudi oil, to be delivered in Greece. Maybe it's Apple stock? So regardless of local markets, the USD has value because it has value to someone who wants to spend it somewhere, and is willing to make local trades for that.

[kenner]

I too struggle to understand the bond market. But don't forget that these bonds are traded on the world market and right now US bonds are yielding more than UK, German, Japaneses, Chinese, French, or Spanish ones: https://www.wsj.com/market-data/bonds

A huge part of the demand for US Treasuries is driven by expectations for the strength of the dollar against other currencies.  The Fed committing to fighting inflation and squashing inflation is bullish for the dollar.  The 10 year Treasury is sort of the benchmark for the pricing of all other dollar denominated bonds.

At the same time, the trade imbalance is widening.  We buy more foreign goods and services with US Dollars. The dollars are no use in the foreign country and must be used to buy American goods/service or American assets. The 10 year T is sort of the default, especially for foreign central bank currency reserves.

Hi @Financial.Velociraptor. Could you explain the bolded text some more? Why can't the recipient just convert US currency to the local currency? I'm not understanding how this is connected to US bond price. It's probably one of those nuanced or counterintuitive points one might need a little more foundation to understand. Thanks!

Bro!  You can totally change your Dollars for local currency.  But only to someone who actually needs/wants USD.   You only want USD if you intend to buy US goods/services OR US assets.   The default US asset is the 10 year Treasury.  Ultimately, USD can only be spent in the US.

And a good bit of the Caribbean where the dollar has become the de facto currency because of US tourism. ;)

There are also places where it's not even de facto, it's a codified legal option...Ecuador, Panama, and Zimbabwe offhand, there are probably others that I've never been anywhere near.