The bond market is larger than the stock market and, many professionals argue, smarter. Bond yields set the cost of mortgages, corporate loans and government borrowing, and they influence how much investors will pay for stocks. You do not need to own bonds to benefit from understanding them.
What is a bond?
A bond is a loan. You lend money to a government or company; in return it pays regular interest, the coupon, and repays the face value at maturity. A 10-year government bond with a $1,000 face value and a 4% coupon pays $40 a year for ten years, then returns $1,000.
Why prices and yields move in opposite directions
Once issued, bonds trade in the market and their prices change. Suppose you own that 4% bond, and new 10-year bonds now pay 5%. Nobody will pay you $1,000 for $40 a year when they can buy a new bond paying $50. Your bond’s price must fall until its effective return, its yield, matches the market. If new bonds paid 3% instead, your 4% bond would become more valuable and its price would rise. So:
When interest rates rise, existing bond prices fall. When rates fall, bond prices rise.
This is why headlines say “yields jumped” when bond prices drop. They are two sides of the same coin.
Duration: how sensitive is a bond?
Duration, measured in years, estimates how much a bond’s price changes when rates move. A bond with a duration of 7 will lose roughly 7% if yields rise by one percentage point. Longer maturities and lower coupons mean higher duration and more sensitivity. That is why long-term bonds suffered heavy losses when rates rose quickly in 2022, while short-term bonds held up far better.
Credit risk
Government bonds from stable countries are considered very low default risk. Corporate bonds pay more to compensate for the chance the company cannot repay. Rating agencies grade issuers; bonds below investment grade are called high-yield or “junk” bonds. The extra yield over government bonds, the credit spread, widens when investors grow nervous about the economy.
The yield curve
The yield curve plots yields of government bonds across maturities, from three months to 30 years. Normally it slopes upward: lenders demand more to tie up money for longer, and they expect growth and some inflation ahead.
- Normal (upward): healthy growth expectations.
- Flat: uncertainty; often a transition phase.
- Inverted (downward): short-term yields exceed long-term yields.
Why an inverted curve gets attention
Short-term yields track the central bank’s policy rate. Long-term yields reflect expectations for growth, inflation and future rates. When the central bank raises short rates aggressively while investors expect a slowdown that will force future cuts, the curve inverts. In the US, an inversion of the 10-year minus 2-year (or 10-year minus 3-month) spread has preceded most recessions of the past half-century, typically by many months to a couple of years.
It is a warning, not a timer. Lead times vary widely, and the signal has produced long delays. Many analysts pay as much attention to when the curve re-steepens after an inversion.
How bonds affect stocks
- Higher yields make bonds more attractive relative to stocks, pulling money away from equities.
- Stock valuation models discount future profits using interest rates; higher rates reduce what those profits are worth today. Long-duration growth stocks feel this most.
- Rising borrowing costs squeeze heavily indebted companies.
Bonds in a portfolio
Bonds provide income and often (not always) cushion portfolios when stocks fall in recessions. Short-term and inflation-protected bonds reduce interest-rate risk. Bond ETFs make it easy to own diversified baskets. See building a diversified portfolio for how bonds fit alongside stocks.
Watch it live
Our bonds dashboard shows US 2-, 5-, 10- and 30-year yields alongside major global 10-year yields. Comparing the 2-year and 10-year at a glance tells you the shape of the curve today.
Key takeaways
- Bond prices and yields move in opposite directions.
- Duration measures interest-rate sensitivity; longer means more volatile.
- Credit spreads reveal how worried investors are about defaults.
- An inverted yield curve is a historically reliable but imprecise recession warning.
Educational content only, not investment advice.