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The Bond Market

The Bond Market
Markets based in the U.S. or worldwide do not always act as separate entities.  They are interrelated in many ways and are affected by developments in other markets.  When money comes in or goes out of the U.S. stock markets it will go into other markets such as the fixed income market (bonds) commodities or currencies. By looking at these other markets we can better analyze from a technical standpoint the odds of a particular market moving in a certain direction.  This might provide opportunity in certain market sectors.  We will look at the bond market and try to explain the way it interrelates with the stock market. 

The bond market that we will refer to is the U.S. Treasury Bond market. U.S. treasury bonds are issued by the U.S. Government to finance its diverse expenditures. These bonds are zero coupon. This means that they do not pay a regular quarterly interest coupon. Instead they are placed at a discount to their face value.  For example the U.S. Treasury is placing a one year bond that would yield 3% at expiration. In order to pay the interest rate the treasury will place a bond with a face value of $1000 at a price of $970. Then at the expiration date (1 year) it would redeem the bond for its face value. Thus the holder would receive $30 additional to what it paid for the bond which would equal a yield of 3%. From this explanation we can conclude that the yield to price relation of these bonds is an inverse one. That is when the prices of these bonds rise (more demand than supply) the yield will decline and vice versa. Traders will often look at specific expirations for clues as to the market's expectations in regards to interest rates and as a way to analyze the flows of funds in this market. The most popular expiration for traders to watch is the 10 Year Bond. 

Bonds and stocks often interact in very specific patterns as supply and demand of funds flows between these two markets. One basic principle says that rising bond prices (lower yields) would go hand in hand with higher stock prices.  As yields in bonds fall investors gravitate towards stocks because they feel bond investments are not paying enough return.  The opposite is true when interest rates rise.  As bond prices fall the yields move higher.  Investors exit stocks for the more favorable bond yields.  If yields are moving up then the mindset of some investors is Why risk money in stocks when I can get a risk free much safer play in bonds with a decent return (higher yield) Of course as investors flock to bonds it causes bonds prices to move higher producing lower yields.  Thus bonds work just like stocks the first ones in and the first ones out make the most cash and the cycle starts all over again. 

Professional traders will look periodically at a bond price or yield chart trying to determine whether the bond market confirms the current stock market trend (as long as bond prices keep acting inverse) or whether there is a discrepancy in this relation that will make us look closely for signs of potential reversals. Intraday we look at a 5 minute chart. The bond market closes at the 3:00 pm.  Its direction at the close will likely determine if stock traders will accelerate their trading or whether they will reverse their positions or just close their positions for the day.







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