If you’re new to finance, you might have heard that when interest rates fall, U.S. bond yields become less attractive. But what does that really mean? Let’s break it down in simple terms.
What Are Bond Yields?
A bond is like a loan—you lend money to the government or a company, and they promise to pay you interest (called a coupon) at regular intervals. The bond yield is the return you get from holding that bond.
How Do Interest Rates Affect Bond Yields?
When the Federal Reserve lowers interest rates, new bonds start offering lower coupon payments. This makes existing bonds (which have higher coupon rates) more valuable, so their prices go up. But here’s the catch:
- Bond Prices and Yields Move in Opposite Directions
If bond prices go up, the yield (return on investment) goes down. This happens because when people buy bonds at higher prices, the return they get relative to the price they paid is lower.
Why Do Lower Yields Make Bonds Less Attractive?
- Lower Returns: Investors who want higher profits may look elsewhere, like stocks or real estate.
- Foreign Investors Look for Better Deals: If bonds from other countries offer higher yields, global investors may move their money there instead of U.S. bonds.
- Less Incentive to Hold Bonds: People might prefer to spend or invest in other assets rather than park their money in bonds.
The Big Picture
Lower interest rates help businesses and consumers borrow money more easily, boosting the economy. But for investors looking for a steady return, falling bond yields can make U.S. bonds less appealing.
Want to invest wisely? Always consider how interest rates impact different types of investments!