The Relationship between the Bond Market and Interest Rates

The bond market is a financial market where investors and traders buy and sell debt securities.  The bond market is commonly used to indicate changes in interest rates because bond valuations and interest rates are inversely proportional.

Bond prices go down when interest rates rise, and they go up when interest rates fall. This happens because most bonds are issued with a fixed interest which, while expressed as a percentage at issuance, is set in dollars. When interest rates rise and investors can get higher returns elsewhere, the prices of existing bonds must be adjusted downward to place them at par with new offerings.

Nearly 90% of the $822 billion U.S. bond market is held by institutions like banks, mutual funds and retirement accounts. Only about 10% of the market is help by private citizens. The U.S. is the largest bond market in the world with a 39% of the global share. That’s why the entire world pays very close attention to the U.S. bond market since it can impact global financial markets and economies.

Unlike the volatile stock market, bonds provide an element of stability. However, their values are susceptible to economic changes, the biggest factor being rising interest rates. Fluctuations in interest rates are not a factor if bonds are held through their maturity because investors get the originally promised amount. It only matters if bonds are bought and sold like stocks.

Interest rates are the cost of borrowing money. When interest rates fall, corporations and governments rush to borrow so that they can lock in low rates or refinance old higher interest borrowings. This inundates the market with new bonds. When interest rates are high, financial institutions and private investors are reluctant to borrow, which results in slowing down or stopping new bond offers. Because of the interest rate risk, bonds with longer terms are more risky than bonds with shorter terms.

In conclusion, since interest rates and the housing market are like two sides of a coin, it is imperative for real estate professionals to be knowledgeable about the bond market and its implications on the mortgage industry.