Government bonds


Government bonds

What Moves the Prices & Yields of Bonds?

Before we explain what drives the prices and yields of governement bonds it’s important to make clear that the relationship between bond prices and yields is a fundamental aspect of fixed-income investing, characterized by an inverse correlation.

When the price of a bond rises, its yield falls, and vice versa as we explained in our previous guide. This dynamic is rooted in the fixed nature of a bond’s coupon payments.

For instance, if a bond with a fixed coupon payment becomes more expensive (its price increases), the same fixed payment represents a smaller percentage of the investment, thus reducing the yield. Conversely, if the bond’s price drops, the fixed coupon now constitutes a higher percentage of the lower price, increasing the yield.

Therefore, any factor that affects the price of a bond, such as changes in interest rates, inflation expectations, or changes in the issuer’s credit rating, indirectly influences its yield. For example, if interest rates rise, bond prices typically fall to offer a competitive yield in line with the new, higher rates, reflecting this intrinsic price-yield relationship.

Key Takeaways of the factors that influence bond prices and yields.

  • Interest Rate Changes: Central bank rate adjustments directly influence bond prices.
  • Inflation Expectations: Anticipated inflation impacts the real return on bonds, affecting their prices.
  • Economic Growth Indicators: Signs of economic strength or weakness can lead to changes in bond demand and prices.
  • Credit Rating Fluctuations: Changes in a government’s credit rating can significantly alter bond risk perceptions and prices.
  • Political Stability or Turmoil: Political events and stability levels can drive bond prices up or down.
  • Market Sentiment and Speculation: Investor expectations and market sentiment influence bond price movements.
  • Supply and Demand Dynamics: The amount of bonds issued versus demand affects their market prices.
  • Global Economic and Geopolitical Events: International events can have a ripple effect on bond prices worldwide.

Government bonds get issued all the time. The US Treasury Department, for example, auctions off new bonds every few days, with maturity dates ranging from four weeks all the way up to 30 years.

The initial yield of a new bond is determined when it’s first auctioned, with investors submitting bids based on the prevailing central bank target interest rate at the time.

In general, the longer the maturity, the higher the yield investors demand: we have no idea what the world will look like 30 years from now, so a bet on the US government’s long-term stability typically carries more risk than a bet on it still being around one year from now.

As ever, investors need to be compensated for that increased risk with an increased return. At the time of writing, a one-year Treasury bill offers a yield of ~4.8%, while a 30-year bond yields ~4.37% (the US uses different terms – bill, note, bond – to denote different debt maturities while in UK they are called Gilts.)

Once the bonds are in investors’ hands they start trading on the secondary market, where their prices move based on macroeconomic factors.

Interest rates

The primary driver, again, is the interest rate set by a central bank, which in turn affects the rate of interest available throughout an economy. If rates fall lower than a bond’s yield, that bond (depending on its maturity) may be a good investment: why put money in a bank account if the government will pay you more?

Investors will likely buy those bonds, driving their price up and their yield – the coupon payment as a percentage of that price, remember – down.

Similarly, if the government wants to issue new bonds after rates have gone down, it’ll want to take advantage of the new environment – so they’ll be issued at lower yields than the last batch. Of course, rising interest rates tend to have the opposite effect.

As a basic cheat sheet:

Falling interest rates → higher bond prices → lower bond yields

Rising interest rates → lower bond prices → higher bond yields

Ιn reality, prices tend to move before things actually happen – so bond prices often indicate what investors think is going to happen next to interest rates. That also explains why falling rates don’t always lead to lower yields.


Investors might worry that lower interest rates will overstimulate the economy and spark excess inflation, which erodes the value of money. Inflation is toxic for bonds, as it makes their coupon payments and maturity repayment worth less over time.

So when rates are lowered, longer-term bonds might see their prices fall as investors demand a higher yield to compensate them for the anticipated extra inflation.

If inflation does eventually overshoot, however, the central bank will usually raise interest rates again to rein it in – meaning that long-term bond yields should end up reflecting long-term interest rates.

Inflation-protected bonds? Because of the threat that inflation poses to bonds, some have protection built in their coupon payments change according to inflation. These bonds, called Treasury Inflation Protected Securities or TIPS in the US, actually become more popular when inflation is high, driving their prices up.

Risk & fear

The other big mover of bond prices is risk. Because the UK and US have never full-on defaulted on their debt, their bonds are considered an extremely safe investment. So when uncertainty is high – if, for instance, investors expect an imminent recession to cause the stock market to plunge – people retreat to that safety.

Bond prices go up, and their yields go down (which, if a recession does hit, makes sense: the central bank will likely cut interest rates).

Investors are also sensitive to the individual riskiness of any given bond. If a country stops looking safe and a default becomes more likely, investors will demand a better return to compensate them for the added risk.

So when a credit rating agency downgrades a country’s rating, its bonds’ prices will fall until their yield looks suitably juicy.

Greek government bond yields had to grow very juicy indeed to tempt investors in 2011...

Greek 🇬🇷 government bond yields had to grow very juicy indeed to tempt investors in 2011. As always, past performance is not a guarantee of future returns.

Growth Indicators and Recession Signals

Economic growth indicators, such as GDP growth, employment data, and consumer spending, play a significant role in the movement of government bond prices. When an economy shows signs of robust growth, as indicated by a rising GDP, decreasing unemployment rates, or increased consumer spending, it generally leads to expectations of higher interest rates.

This anticipation is grounded in the central bank’s likely response to curb inflationary pressures arising from rapid economic growth. As interest rates increase, the yield offered by newly issued bonds becomes more attractive, making existing bonds with lower yields less desirable. This shift results in a decrease in the market price of existing bonds.

Moreover, strong economic data often encourages investment in riskier assets, such as stocks, reducing the demand for safer investments like government bonds, further contributing to the downward pressure on bond prices.

In contrast, indicators of an economic slowdown or impending recession have an opposite effect on government bond prices. Signals like declining GDP, rising unemployment, and reduced consumer spending can lead to a flight to safety, with investors seeking the relative security of government bonds.

This increased demand drives up bond prices. Additionally, in such economic climates, central banks often implement measures to stimulate the economy, typically by lowering interest rates. Lower interest rates make new bonds less attractive due to their lower yields, increasing the appeal of existing bonds with higher yields. Consequently, the prices of these existing bonds tend to rise.

This phenomenon reflects the bond market’s role as a barometer of economic health, where investors’ perceptions of risk and the central bank’s monetary policies in response to economic conditions significantly influence bond prices.

Credit Rating Changes

Risk Assessment: The credit rating of a government is a crucial factor in determining the risk level associated with its bonds. Credit ratings, provided by agencies like Moody’s, S&P, and Fitch, assess the government’s ability and willingness to repay its debt.

A downgrade in a government’s credit rating signifies increased risk, suggesting potential difficulties in meeting debt obligations. Such a downgrade leads to a decrease in bond prices and an increase in their yields. This is because investors demand a higher yield to compensate for the added risk. Conversely, an upgrade in credit rating has the opposite effect, signaling a healthier economic state and lowering the risk of default.

This typically results in an increase in bond prices and a corresponding decrease in yields. The impact of credit rating changes on bond prices highlights the sensitivity of the bond market to perceived risk, making credit ratings a crucial component in bond valuation

The political landscape of a country can have a profound impact on its government bond prices. Political stability and effective governance contribute to a positive investment climate, often resulting in higher bond prices and lower yields, as the risk is perceived to be lower.

On the other hand, political turmoil, such as government instability, policy uncertainty, or geopolitical conflicts, can lead to increased risk and uncertainty.

Investors, in such scenarios, may demand a higher risk premium for holding government bonds, resulting in lower bond prices and higher yields. This reaction is particularly pronounced in countries where political instability is a frequent issue, as it can lead to concerns about the government’s ability to manage its finances and uphold its debt obligations.

Thus, the political environment is a key factor for investors to consider, as it can directly influence the risk and return profile and prices of government bonds.

Supply & demand

Bond supply is another factor that affects prices. If governments embark on big spending projects and issue lots of bonds to fund them, prices might be driven down.

And if a central bank, trying to stimulate the economy, starts a quantitative easing program of buying up bonds, that’ll restrict supply and boost prices – part of the reason why bond prices have been on a tear since the last financial crisis and up to 2022.

As maturity comes

All these factors influence a bond’s price between its issuance and its maturity date. But as that maturity nears, the bond’s price will gradually return to its par value: a week before maturity and with no coupon payments left, a $100 bond is only worth $100.

Unlike stocks, which can gain in price and stay that way, bond price movements are transient – you can only benefit from them by selling before maturity.

Over time, you’ll spot recurrent patterns. Bonds are a “counter-cyclical” investment: they’re most popular in times of economic slowdown, as discussed – less popular during booms, when stocks offer better potential returns – and then back in vogue as the bustman comeths.

And there are also longer-term trends. Bond yields seem to be stuck permanently lower than they were 40 years ago; a return to the 15% yields of the ‘80s seems unlikely.

But low yields don’t mean bonds aren’t worth investing in. In the next session, we’ll look at how investors can analyse a given government bond to see if it’s right for you.

The takeaway

Higher interest rates, inflation, increased credit risks, and growth or recession signals drive bond prices down or up. But price changes for any given bond are transient: at maturity, it’ll simply be worth its par value.


Never forget that when you invest, your capital is at risk. This learning guide is for information purposes only and is not intended as investment advice.

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