🎯 In 30 seconds: A bond pays fixed interest, so when market rates rise, existing bonds lose value, and the longer the bond, the bigger the drop. Bond yields matter to stock traders because they set the return investors can get without taking stock risk. When yields rise, every future dollar of company profit is worth less today, and some kinds of companies feel it more than others. Stocks and bonds sometimes move in opposite directions and sometimes fall together. Watching the 10-year Treasury yield, the gap between corporate and Treasury yields, and inflation-adjusted yields tells you a lot about the mood stocks are trading in.
Bond basics in one minute
A bond is a loan you make to a government or company. It has a face value (usually $1,000), a coupon (the fixed yearly interest, often paid in two halves), and a maturity date when the face value is repaid. US Treasury bills, notes and bonds are loans to the federal government, which is why they are treated as the low-risk benchmark.
A bond's price moves in the market every day. Its yield to maturity is the yearly return you would earn if you bought at today's price and held to the end. Price and yield are two ways of stating the same thing, and they move in opposite directions.
This chapter builds on The economy and stocks, which covers the Federal Reserve, the three channels from rates to stock prices, a worked valuation example and the yield curve. Here the focus is on the bond side, and on what it means for different parts of the stock market.
Why bond prices fall when yields rise
You own a 10-year Treasury bought at issue for $1,000 with a 4% coupon: $40 a year. Then new 10-year bonds start paying 5%. Nobody will pay you $1,000 for $40 a year when $1,000 buys $50 a year elsewhere. Your bond's price has to fall until its yield to a new buyer is also 5%.
How far it falls depends mostly on how long is left to maturity. Here are 4%-coupon bonds, each worth $1,000 at a 4% yield, repriced at other yields (calculated with semiannual payments):
| Market yield | 2-year bond | 10-year bond | 30-year bond |
|---|---|---|---|
| 3% | $1,019 | $1,086 | $1,197 |
| 4% | $1,000 | $1,000 | $1,000 |
| 5% | $981 | $922 | $845 |
| 6% | $963 | $851 | $723 |
A handy shortcut is duration, measured in years. A bond's price changes by roughly its duration times the change in yield, in the opposite direction. The 10-year bond above has a duration of about 8.2, so a 1-point rise in yields should cut its price by about 8.2%. The exact answer from the table is 7.8%. The 30-year bond's duration is about 17.4, the 2-year's about 1.9. Duration is the bond market's word for "how sensitive to rates".
How bond yields reach stock prices
Stock investors use bond yields in two main ways.
As the discount rate. A stock's value rests on profits far into the future. Investors convert those future dollars into today's dollars using a required return built on top of safe yields. When Treasury yields rise, that required return usually rises too, and distant profits lose the most value. The economy and stocks shows the arithmetic.
As the competition. A common rough comparison is the earnings yield, which is earnings per share divided by price: the P/E ratio turned upside down. If an index trades at 20 times earnings, its earnings yield is 1 / 20 = 5%. Investors set that against the 10-year Treasury yield to ask how much extra they are paid for owning stocks.
Treat this as a thermometer, not a timer. Earnings can grow while a bond's coupon cannot, and the earnings figure itself can be inflated by a good year. Markets have spent long stretches with a small or negative gap. What the comparison does tell you: when safe yields rise sharply and stock valuations do not adjust, stocks are carrying more risk for less extra pay.
Real yields, inflation and credit spreads
Three more numbers help you read the bond market's message:
- Real yield. The yield after inflation. Treasury Inflation-Protected Securities (TIPS) have principal that adjusts with the Consumer Price Index, so their yield is roughly a real yield. The Treasury publishes a daily real yield curve. Rising real yields tend to hit long-dated growth stocks hardest, because they raise the true cost of waiting for profits.
- Breakeven inflation. A regular Treasury yield minus a TIPS yield of the same maturity. It is the inflation rate at which the two would pay the same, a rough gauge of what bond traders expect inflation to be.
- Credit spread. The extra yield a company's bonds pay over a Treasury of similar maturity. High-yield bonds (lower credit ratings) pay more than investment-grade bonds for the extra default risk. When spreads widen quickly, lenders are worried about companies' ability to pay, and that worry often shows up in stock prices too.
Do stocks and bonds move together or apart?
Both. It depends on what is driving markets.
When the worry is a weak economy, investors often sell stocks and buy Treasuries for safety. Yields fall, bond prices rise, and bonds cushion a stock portfolio. That happened in the 2008 financial crisis.
When the worry is inflation and rising rates, both can fall at once. In 2022, as inflation hit 40-year highs and the Federal Reserve raised rates fast, stocks and high-quality bonds both lost value. See the 2022 row in Bull and bear markets.
So bonds are not a guaranteed hedge. They tend to help in growth scares and can hurt alongside stocks in inflation scares. Diversification and correlation explains why correlations shift.
Which stocks feel rising rates most
These are tendencies, not rules. Company specifics, like how much debt is fixed versus floating, often matter more than the sector label.
| Kind of company | Why rates matter | Usual direction when yields rise |
|---|---|---|
| Utilities | Heavy borrowers with steady dividends that investors compare with bond income | Often lag |
| Real estate (REITs) | Borrow heavily and pay out most income, so they compete with bonds for income buyers | Often lag |
| Fast-growing, low-profit companies | Most of their value rests on profits many years away | Often hit hardest |
| Homebuilders, car makers | Their customers borrow to buy | Demand can slow |
| Companies with lots of floating-rate debt | Interest bills rise with rates | Profits squeezed |
| Banks | Can earn more on loans, but deposits get pricier and bond holdings lose value; an inverted curve squeezes margins | Mixed |
| Insurers | Invest premiums in bonds and earn more on new money over time | Often helped over time |
Banks show why "mixed" is the honest label. When Silicon Valley Bank failed in March 2023, the Federal Reserve's own review said its leaders had failed to manage basic interest rate and liquidity risk. Rising rates had cut the value of the long-term bonds it held at the same time depositors pulled money out.
Try it
Work out the price of a 10-year, 5%-coupon bond if market yields fall from 5% to 4%, using the duration shortcut. Its duration is about 7.8. (Answer: roughly +7.8%, so about $1,078. The exact price is $1,082 because of the curve's bend.)
Then build a small rate-sensitivity test in the paper portfolio: one utility, one REIT, one fast-growing unprofitable company and one insurer, equal dollar amounts. Record the 10-year Treasury yield each Friday for eight weeks next to each position's value. Which ones moved with yields, and which ones did not care?
- Market yields rise from 4% to 5%. Which loses more, a 2-year or a 30-year bond with a 4% coupon? Answer: The 30-year, about 15.5% versus about 1.9%, because its cash flows are further away.
- An index trades at a P/E of 20. What is its earnings yield? Answer: 1 / 20 = 5%.
- Why can stocks and bonds fall together? Answer: When inflation and rising rates are the main worry, higher yields push bond prices down and also lower the value of future company profits, as in 2022.
- What does a quickly widening credit spread suggest? Answer: Lenders want more pay for default risk, a sign of worry about companies' ability to pay.
Sources
- SEC Investor Bulletin: Interest Rate Risk, when interest rates go up, prices of fixed-rate bonds fall
- Investor.gov (SEC): Bonds FAQs
- US Treasury: Daily Treasury Par Yield Curve Rates
- TreasuryDirect: Treasury Inflation-Protected Securities (TIPS)
- Federal Reserve: Review of the supervision and regulation of Silicon Valley Bank (April 2023)