Trading Bonds-64

Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds

Page 64

attractive relative to others, the pool of money is shifted from the outof- favor instruments to the favorable one. There are times when the prices of real estate, stocks, or precious metals are too high to justify or too volatile to stomach. In these cases investors siphon out their money from these investments and pour it into bonds, most notably the safe long bond. This is sometimes referred to as “flight to quality,” where although bonds may not provide as sexy of a return as other investments, they have guaranteed income (interest payments) and, in the case of the long bond, are backed by the federal government. This demand for bonds causes their prices to move up. The reverse is also true when investors may decide to sell their bond holdings to move to other attractive investments. In that case bond prices drop in response to the sell-off.

Fed Moves
The Federal Reserve has a significant impact on bond prices. That is because the Fed is tasked with adjusting the interest rates to keep the economy on course for moderate expansion and to head off inflationary threats. As we discussed earlier, the Fed basically makes the adjustments to the overnight lending (federal funds) rate. However such changes quickly cascade to bond prices such that the yields come in alignment with the overall interest rate picture. The Fed is under constant scrutiny by the media and financial institutions for any hints of possible interest rate actions. The slightest indication of possible Fed action could send the bond prices in the anticipated direction. For example, if it is anticipated that the Fed will raise interest rates, or if the Fed does so unexpectedly, bond prices move lower, causing the bond yields to move up, proportionally matching the Fed interest rate hike. An interest rate cut by the Fed has the opposite effect, and bond prices move higher in response. …