February 21, 2021

• Falling interest rates make bond prices rise and bond yield falls. On the contrary, increasing interest rates make bond prices go lower and bond yields increase.

Fed decreased interest rate:

• US Fed decreased the interest rate to 0.25% in response to the Coronavirus crisis.
• Lower interest rates disincentivize investors from buying bonds and channel that money into riskier assets like stocks.
• With lowering the interest rates, bond investors think the bonds currently trading in the market will give them more interest since they were issued in the past at a higher rate. This pushes the prices of the bonds higher.
• Higher bond prices push the bond yields lower because bond prices and yields are inversely related.
• At the same time, in order to stimulate the economy, Fed buys bonds from the market and inject that cash into the hands of the people so they can invest it into the businesses.
• Over the period of the time, this increases the economic activity and investors' optimism. Assets prices starts to go up which leads the inflation to start going up.
• Also since investors were buying stocks and not bonds, this leads the bond prices to fall. And since bond prices and yields are inversely related, the yields starts to pick up.
• Yields continue to increase at a level where investors think that it's better to invest in the risk-free assets than riskier assets like stocks. Generally this rate is between 2%-3%. As of February 21, 2021 the 10 year treasury yield is 1.34%.
• So today investors are worried that yields will continue to rise and money will be shifted towards bonds which will lead to a correction in the stock market.
• This complete the cycle that how change in the interest rate impacts the treasury yields.
• A side note, investors are also worried that in inflation rate keeps going up, somewhere Fed will increase the interest rate. And that's because interest rates and inflation rates are inversely related. When the interest rates will go up, there will be correction in the stock market.

Conclusion:

• Watch the treasury yields and see if there will be a correction in the stock market. Important points will be 1.5% and 2%.
• Watch the inflation rate. Fed's current long-term goal rate is 2%.