Why bond prices fall when yields rise
News reports say "bond yields rose" as if that were good news for bondholders. Usually it is the opposite: when yields rise, the bonds people already own lose value. The reason is simple once you see it, and it explains much of what happens in markets when interest rates change.
The terms you need
Each definition is followed by a real example.
- Government bond
- A loan to a government. The buyer pays a price today, receives a fixed interest payment (the coupon) every year, and gets the face value back when the bond matures.
- Coupon
- The fixed interest a bond pays each year, set when it is issued. The coupon never changes; what changes is the price people will pay for the bond, and so the yield a new buyer earns.
- Bond yield
- The annual return a buyer earns by purchasing a bond at today’s price and holding it to maturity. When a bond’s price falls, its yield rises. The 10-year yield is the benchmark for mortgages and long-term business loans.
- Duration
- A measure of how sensitive a bond's price is to changes in yields, roughly the percentage its price changes for a one-point move in yields. The longer the bond, the higher its duration.
- Yield curve
- The line joining yields on government bonds of different maturities, from months to 30 years. Normally longer bonds pay more. When short yields are above long ones, the curve is 'inverted', often read as markets expecting rate cuts ahead.
- Real interest rate
- An interest rate minus inflation. It shows what borrowing really costs once rising prices are taken into account.
Fixed payments, moving prices
A worked example with a £100 bond that pays £4 a year for ten years.
- 1 →You buy a bond paying 4%You pay £100. It pays you £4 a year for ten years, then your £100 back. Those payments are fixed for its whole life.
- 2 →Interest rates riseNew ten-year bonds now pay 5%: £5 a year for the same £100.
- 3 →Your bond must get cheaperNobody will pay £100 for £4 a year when £100 buys £5 a year. Your bond only sells if its price falls until a buyer earns 5% overall: to about £92.
- 4 →Price down, yield upThe price has fallen about 8%, and the yield for a new buyer has risen to 5%. They are the same event, seen from two sides.
- 5And the other way roundIf new bonds paid only 3%, your 4% bond would be worth more: about £109. Falling yields mean rising prices.
For the same rise in yields from 4% to 5%, a two-year bond falls about 2%, a ten-year about 8% and a thirty-year about 15%: the longer you are stuck with the old, lower payments, the bigger the discount. This sensitivity is called duration.
If the issuer does not default, a bond held until it matures repays its full face value. The fall in price is the cost of having locked in a lower rate: real if you sell, or in what you could have earned instead.
The same rise that hurts existing bondholders means anyone buying now, including pension funds and savers, locks in more income for years.
The US 10-year yield rose from 1.47% in December 2021 to 3.62% a year later as the Fed raised rates to fight inflation. The Bloomberg US Aggregate index, a broad basket of US bonds, lost 13% in 2022, its worst year since it began in the 1970s.
Government bond yields are the base rate for mortgages, company loans and the value of shares. When they rise, the future profits of companies are worth less today, which is why share prices, especially of fast-growing firms, often fall when yields jump.
Yields are high by the standards of the past 15 years
What stands out today
- Long-term yields in the US and the UK are near 5%, as investors weigh oil-driven inflation, rate rises and heavy government borrowing.
- The US yield curve slopes upward: the 10-year pays more than the 2-year, the normal shape.
Why it matters now
Every rise in yields this year has cut the value of bonds already held by pension funds, banks and insurers, and raised the cost of new government borrowing. What markets are pricing shows where investors expect rates to go next.
This mechanic in the news
Recent stories that show this mechanism at work, newest first.
Sources and notes
- Worked example: our calculation for a bond paying an annual coupon of 4%, priced to yield 5% (price £92.28) or 3% (£108.53). For 2- and 30-year bonds the prices at 5% are £98.14 and £84.63. Duration of the 10-year bond at 4%: about 8.1.
- US yields: US Treasury (via FRED); 2021–22 figures are monthly averages (GS10). UK 10-year: OECD (via FRED), monthly.
- Bloomberg US Aggregate 2022 return of −13.01%, the index's worst calendar year: as reported by Diamond Hill, January 2023.
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