Bonds and Interest rates

[g4ry13]

As far as my understanding goes on the two, there's an inverse relationship between the two. Interest rates go down, bond prices go up and vice versa.

So why is it that with the interest rate cut the bond price fell ~ 0.60. I thought it'd work the other way around (unless i'm reading the price incorrectly).

Anyone care to shed some light on this?

Cheers

[JohnP68]

I presume you're referring to a gilt - ie Government bond. The simple answer is that you're probably not comparing like with like. The price of a bond depends on the average interest rate expected to apply over the duration of the bond, whereas the Bank base rate is only the interest rate at very short durations. I presume that you've observed a fall in the price of a reasonably long bond, which could happen, if the market has now factored in a further increase in interest rates at some point in the future that it wasn't previously expecting.

If you're really keen, the Bank of England publishes daily yield curve figures for terms up to 25 years on its website. You're probably find that the yield actually increased at the average duration of the bond over the period, despite the reduction in short term rates.

[g4ry13]

JohnP68 said:

I presume you're referring to a gilt - ie Government bond. The simple answer is that you're probably not comparing like with like. The price of a bond depends on the average interest rate expected to apply over the duration of the bond, whereas the Bank base rate is only the interest rate at very short durations. I presume that you've observed a fall in the price of a reasonably long bond, which could happen, if the market has now factored in a further increase in interest rates at some point in the future that it wasn't previously expecting.

In this case I was looking at the US 5, 10 and 30 year bond which expires in December (I'm looking at a spread-betting platform). The cut today, should have led to an increase in the bond price according to the convention of the two working inversely - but it doesn't seem to appear that way. It would probably be too much of an assumption to factor in interest rate increases already in the US to cause such a change in one day so there must be more to it (so i'd like to think.)

[JohnP68]

If the outstanding term of the bond is quite short then the explanation is probably that the market had already expected and priced in a bigger rate cut than actually happened, in which case the redemption yield may have increased following the rate cut.

[LeTim]

Sentiment also plays a part remember. Government bond yeilds can plunge if the markets are nervous or a big geopolitical event happens. As money flees to safety without any need for an interest rate move.

[clubsport]

Oh dear we could get quite deep on this one....An ideal enviroment for bonds is a strong growth non inflationary enviroment.

Yesterday with the US, although we had a 25bp cut fully priced in, there was a slight euphoria of another 50bp cut and don't forget 10 year cash yields had fallen 28bp in the last 2 weeks or so.....so as stated sentiment can have an effect, the market had basically got ahead of itself!

Yesterday the cut was announced with a slightly hawkish statement with regard to future inflation risks..

"Readings on core inflation have improved modestly this year, but recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully. "

Prior to the announcement other data, reflected the raised expectation for the jobs report due tomorrow and new supply of 10 & 30 year cash bonds announced (1/4rly refunding) next week......where was the need for further buying now...quite the reverse!

You mention 5/10/30 year...the greatest impact (as expected) from the cut announcement was seen in the front end of the yield curve with 2/10 year spreads coming in 3bp on the day......you have to take into account so many factors....that is before I bore you with the technical picture which has turned slightly sour!

(as you can tell,,fairly quiet today )

[shadowninja]

g4ry13, bit off-topic, but how many different instruments do you "trade"?

[g4ry13]

Thanks for the inisght about the bond market. There's obviously a lot more to the bond market than purely interest rates. It looks like i'm going to have to learn some more about them if I choose to deal in them. What do you mean about the technical picture though Clubsport, are you talking wiggly lines and joining up dots or something more fundamental to it?

Mr ninja: I'm not actively trading as i'm supposed to be applying for jobs and going to interviews so haven't the time. I'd say i've "traded" around 7 markets, but just sticking to holding shares for the moment. I've got to admit to being sorely tempted to a few recent positions such as GBP/USD and Oil but unfortunately not had the time to capitalise on them. Those 2 with FTSE100 and DJIA, Soybean, Wheat look most interesting at the moment in my opinion.

[shadowninja]

Oh, ok. Was just curious to see where you were looking. I'm only doing Eur/USD and GBP/USD at the mo. There's enough going on with those two pairs to keep me busy.

[g4ry13]

shadowninja said:

Oh, ok. Was just curious to see where you were looking. I'm only doing Eur/USD and GBP/USD at the mo. There's enough going on with those two pairs to keep me busy.

GBP/USD and Oil would be my prime choice at the moment. USD/JPY looks a safer bet. You long or short on GBP/USD? I'm thinking a short is due soon.

Edited by g4ry13 on Thursday 1st November 18:06

[shadowninja]

g4ry13 said:

GBP/USD and Oil would be my prime choice at the moment. USD/JPY looks a safer bet. You long or short on GBP/USD? I'm thinking a short is due soon.

USD/JPY requires such a big stop loss to not get stopped out by the noise.

From the 4 hour charts, I'd be long this week, although I only intraday trade GBP/USD as it requires a big stoploss, too, but yes, it can't last for long, however it may only correct to around the 20700 mark. It's knowing when the turn is about to come that is the tricky bit. Who knows.

That's the fun of it. Anything can happen!

Edited by shadowninja on Thursday 1st November 18:24

[g4ry13]

shadowninja said:

USD/JPY requires such a big stop loss to not get stopped out by the noise.

From the 4 hour charts, I'd be long this week, although I only intraday trade GBP/USD as it requires a big stoploss, too, but yes, it can't last for long, however it may only correct to around the 20700 mark. It's knowing when the turn is about to come that is the tricky bit. Who knows.

I'm surprised you think it needs a bigger stop loss than GBP/USD. Both had over a 100 point range today. i'd consider a stop loss over 150 big, but i'm guessing from what you do it's about 50 points?

Yes, timing is everything in this stuff especially if you're using tight stops. Either way, i'll wait until I get an indication that screams at me and if it co-incides with my spare time. My new theory is it doesn't matter which direction you take your position in, as long as you're patient you can take a profit at some point. I'm busy selling my soul to some grey suits and not happy about it.

Edited by g4ry13 on Thursday 1st November 20:12

[shadowninja]

g4ry13 said:

I'm surprised you think it needs a bigger stop loss than GBP/USD. Both had over a 100 point range today. i'd consider a stop loss over 150 big, but i'm guessing from what you do it's about 50 points?

I think GBP/USD would need a stop of about 100 typically if you're doing position trading; USD/JPY looks like it needs a stop of 150 points. I trade intraday with a stop of 30 points no probs. If it exceeds 30 points, there is a good chance I was wrong with the trade.

[clubsport]

g4ry13 said:

Thanks for the inisght about the bond market. There's obviously a lot more to the bond market than purely interest rates. It looks like i'm going to have to learn some more about them if I choose to deal in them. What do you mean about the technical picture though Clubsport, are you talking wiggly lines and joining up dots or something more fundamental to it?

There is quite a bit more to the technical side than dots and lines, all part of the picture and certainly should not be ignored...whatever you think about the "black art" there are enough participants who take it seriously for it to be very relevent.

Todays move the other way was pure flight to quality asset allocation on the fall in stocks due to capital inadequacy (??) of certin financial institutions.
The soverign nature of US tsys normally takes over in such scenarios,,moves often exagerated and reverse without strong fundamentals to justify the buying...this is where the short term technicals can help you out....have fun

[g4ry13]

clubsport said:

There is quite a bit more to the technical side than dots and lines, all part of the picture and certainly should not be ignored...whatever you think about the "black art" there are enough participants who take it seriously for it to be very relevent.

Todays move the other way was pure flight to quality asset allocation on the fall in stocks due to capital inadequacy (??) of certin financial institutions.
The soverign nature of US tsys normally takes over in such scenarios,,moves often exagerated and reverse without strong fundamentals to justify the buying...this is where the short term technicals can help you out....have fun

I'm personally undecided about the "black art". I find if you use enough indicators it can end up contradicting itself - I find it starts getting a bit silly when people start talking about cups and saucers and head and shoulders formations. Going by the school of thought that a price reflects the true value, the "black art" "should" work. Looking back at charts it's easy to come up with the explanations for the highs and lows. I know there are some city boys on here who have rejected the "black art" as a method of trading. Is it something you'd use in the short-term? If so, which indicators would you use? I know some swear by candlesticks and pivot points. RSI looks pretty good in retro-spect looking back at historic data - i'm thinking it's more accurate than some other indicators but I realise there's a lot more driving the markets than technicals.

[Ordinary Bloke]

I'm looking at rice cakes and maltesers at the moment. Do you think I should worry about inflation???

[g4ry13]

Ordinary Bloke said:

I'm looking at rice cakes and maltesers at the moment. Do you think I should worry about inflation???

Of body parts?

[Ordinary Bloke]

g4ry13 said:

Ordinary Bloke said:

I'm looking at rice cakes and maltesers at the moment. Do you think I should worry about inflation???

Of body parts?

Exactly. I'll start my diet tomorrow. After breakfast...

[ATG]

g4ry13 said:

Thanks for the inisght about the bond market. There's obviously a lot more to the bond market than purely interest rates.

Government bond prices are primarily driven by expectations of how official interest rates (the short-dated rates set by the Fed, BoE, ECB,BoJ etc) will change in the future (i.e. over the life of the bond ... which might be as much as 30 or 50 years). Those official rates are varied in order to try to control inflation, so bond prices are largely driven by expectations of how much inflationary pressure there will be in the economy in the future and how the market expects the central banks will manage to control that pressure. Clearly, when you're trying to forecast inflation for the next 2,5,10 or 30 years, there is huge uncertainty.

If the market thinks that the consequence of a rate cut today will be higher inflation in the next few eyars, then they will assume that average interest rates over the next few years will actually be higher as a result of the current cut. This will harm bond prices. If people think average rates for the next 10 years are going to be higher than they previously thought, they will demand that the yield on a 10 year bond must rise ... and as the yield of a bond is a reciprical function of its price, the price will fall.

By the way, there's nothing magical or mysterious about the inverse relationship between a bond's yield and its price. The bond's payments are fixed in advance. They don't go up and down with interest rates. But obviously what those payments are worth to you [b]now[/i] is determined by interest rates ... i.e. you ask yourself "how much money would I have to save now in order for it to grow to amount X in the future?". The higher interest rates are, the less you have to save now to grow to some fixed amount in the future. Therefore the higher you expect rates to be in the future, the less the promise of a fixed payment in the future is worth to you now.

[clubsport]

G4ry, all different style of trading, some use just techs, some purely fundamentals...I prefer to have an interest in both....basing trading decisions on fundamentals for a macro view, partly finessed/adjusted with techies for the micro view..certainly not saying it is the only way to trade,,,,after a while you tend to develop your own style anyway... candlesticks,RSI,moving averages and stochastics are useful to keep on top of,,,some of this is a bit like a weather forecast, based on the assumption it will be 17 degrees and dry in London today, I will leave the umbrella at home...the long range forecast for November may well have been rain?