Bond yields have generally been lower since 2009, and this contributed to the rise of the stock market. Bond yields in the U.S. declined along with interest rates after the 1970s. Compared to the bond yields of the late 20th century, the yields between 2009 and 2019 were constantly low. The overall trend toward lower interest rates and bond yields is often credited with supporting higher prices in the stock market.
Inflation and the Constantly Low Yield Environment
Bond yields are based on expectations of inflation, economic growth, default probabilities, and duration. A bond yields a fixed amount that is paid regardless of other conditions, so a decrease in inflation raises the real yield of the bond. That makes bonds more attractive to investors, so bond prices rise. Higher bond prices mean lower nominal yields. Inflation and inflationary expectations fell almost constantly between 1980 and 2008. Economic growth also declined after the 2008 financial crisis. Lower expectations for growth and inflation mean that bond yields since 2009 have been constantly low. However, higher growth did lead to slightly higher interest rates and bond yields between 2013 and 2018. Constantly low bond yields do not mean that yields remain at the same low level.
How Growth and the Stock Market Influence Bond Yields
During periods of economic expansion, bond prices and the stock market move in opposite directions because they are competing for capital. Selling in the stock market leads to higher bond prices and lower yields as money moves into the bond market. Stock market rallies tend to raise yields as money moves from the relative safety of the bond market to riskier stocks. When optimism about the economy increases, investors transfer funds into the stock market because it benefits more from economic growth. Economic growth also carries with it inflation risk, which erodes the value of bonds.
Lower Bond Yields Mean Higher Stock Prices
Interest rates are the most significant factor in determining bond yields, and they play an influential role in the stock market. Bonds and stocks tend to move together early in economic recoveries when inflationary pressures are weak. During those times, central banks are committed to low interest rates to stimulate the economy. This lasts until the economy begins to grow without the aid of monetary policy or capacity utilization reaches maximum levels where inflation becomes a threat. Bond prices and stock prices both move up in response to the combination of mild economic growth and low interest rates.
The Role of Defaults in Bond Yields
The probability of default also plays a significant part in bond yields. When a government or corporation cannot afford to make bond payments, it defaults on the bonds. Investors naturally demand higher yields from organizations that are more likely to default. Federal government bonds are generally considered to be free of default risk in a fiat money system. When corporate bond default risk increases, many investors move out of corporate bonds and into the safety of government bonds. That means corporate bond prices fall, so corporate bond yields rise. High-yield or junk bonds have the highest default risk, and default expectations have more influence on their prices. During the 2008 financial crisis, default expectations for many companies rose significantly. As a result, corporate bonds temporarily offered higher yields.