Articles by Tom Czitron

Business

Bonds in the Headlines: What You Need to Know

Bonds tend to be taken for granted by the general public. Just before I sat down to write this piece, I was listening to the local all-news radio station and noticed that neither bonds nor interest rates were mentioned in its market report. The announcer noted that Nvidia stock was under pressure. The program listed the levels of the S&P 500, Dow Jones, NASDAQ, and TSX indices, as well as the prices of gold and oil. That’s understandable. Stock indices, oil, gold, and cryptocurrency are more glamorous and attention-grabbing than bonds. Also, individual bonds are primarily an institutional market. Most trading is executed by institutional brokers on behalf of pensions, mutual funds, and other large capital pools. When was the last time your neighbor told you to buy a “hot” bond? Still, the fact that bonds don’t get much media coverage doesn’t mean they aren’t vitally important. There’s a lot of buzz around gold, but the price of gold has minimal real-world impact on most Americans or Canadians. Bonds, however, affect everyone—whether they realize it or not. When bond prices change, so do their yields to maturity—essentially the effective interest rate. And interest rates influence nearly every aspect of daily life. Bonds represent governments borrowing money to fund what tax revenues don’t cover. In the United States, the Federal Reserve sets the benchmark overnight interest rate. In Canada, it’s the Bank of Canada. In late October, the Bank of Canada reduced its policy rate from 2.5 percent to 2.25 percent. The Bank’s objectives are to maintain low inflation and maximize employment. When inflation is the primary concern, rates are raised to slow the economy. When growth is sluggish and unemployment rises, the Bank cuts rates to stimulate activity. This process is known as monetary policy. However, monetary policy is a blunt tool. Once inflation picks up, it can be hard to rein in. And central banks have sometimes overcorrected by raising rates too high or keeping them elevated too long, leading to recessions. Today, many Western central banks are caught in a bind. Post-pandemic inflation remains high, yet economic growth is weak. People in both the United States and Canada are acutely aware of how rising grocery prices and elevated unemployment are eroding their standard of living. The longer the maturity of a government bond, the less control the central bank has over its yield. When I was managing bond portfolios, it was accepted that while the central bank controls overnight lending rates, the market sets the price and yield of 30-year bonds. By the five-year mark, central bank influence largely disappears. And bond yields influence mortgage rates. The yield curve—a graph plotting interest rates (vertical axis) against bond maturities (horizontal axis)—shows this relationship clearly. The spread between short- and long-term bond yields can vary widely. In December 2009, following the financial crisis, 10-year U.S. Treasury bonds yielded 3.7 percentage points more than three-month T-bills. In May 2023, they yielded 1.88 percentage points less. Typically, longer-term bonds yield more to compensate investors for greater default risk and price volatility. A one-point rise in yield may not affect a T-bill much—but it could cut the value of a 30-year bond by around 15 percent. Mortgage rates are based on interest rates—something many people are now confronting as they renew at sharply higher monthly payments after years of historically low rates. Those ultra-low rates helped drive the housing boom until 2022. The current high-rate environment has reversed that trend, with condo prices plunging in some cities. Even renters aren’t immune. If your landlord has a mortgage, rising rates may translate into higher rent. The same applies to your line of credit, car loan, and credit card debt. We should all pay attention to bond yields. They affect nearly every part of our economic lives—personally and collectively. Interest rates are, in essence, the price of money.