What happens to treasury bond yields when investors are concerned about economic uncertainty due to new tariffs? Will yields be higher or lower?

 

Seminar Room, Discussion on Treasury Bonds Dynamics and Investor Behavior (Simulation)

Professor Rowe addresses a small seminar group of second-year students in economics and finance.

Prof. Rowe:
Good afternoon, everyone. Today, we’ll explore a cause-and-effect relationship involving economic concerns, investor behavior, bond prices, yields, and why they move higher or lower.

Alex:
They seek safer investments, right?

Prof. Rowe:
Exactly, Alex. Investors often move their money away from riskier assets like stocks and toward safer options like U.S. Treasury bonds. Why do you think investors prefer bonds during uncertain economic times?

Maria:
Because U.S. Treasury bonds are backed by the government, they are very secure investments.

Prof. Rowe:
Precisely, Maria. Now, what happens to bond prices when investors start buying more bonds?

Jaden:
Prices go up because demand increases.

Prof. Rowe:
Exactly. Let’s break it down clearly: Increased demand for bonds increases prices. Priya, can you explain the relationship between bond prices and bond yields?

Priya:
They move in opposite directions. So, when bond prices go up due to high demand, yields fall.

Prof. Rowe:
Great explanation. Let’s illustrate this clearly. Suppose you have a bond worth $1,000 paying $30 per year in interest, yielding 3%. If strong demand increases the market price to $1,050, the yield for a new buyer becomes about 2.86% ($30 divided by $1,050). Thus, bond yields drop when bond prices rise.

Alex:
Is that why yields fall during economic uncertainty?

Prof. Rowe:
Exactly right, Alex. Investors' flight to safety raises bond prices, pushing yields downward. But there’s another layer here: expectations about central bank actions. What might investors expect the Federal Reserve to do if the economy shows signs of weakness?

Maria:
They might expect the Fed to cut interest rates to stimulate the economy.

Prof. Rowe:
Precisely, Maria. If investors anticipate lower future interest rates, how does this expectation affect existing bonds?

Jaden:
Existing bonds, which offer higher rates, become more attractive than new bonds issued at lower rates.

Prof. Rowe:
Exactly, Jaden. Anticipating future rate cuts makes existing bonds with higher yields more valuable, driving their prices even higher and yields even lower.

Priya:
So it's like a reinforcing cycle—economic concerns cause bond demand to rise, which lowers yields, and then the expectation of rate cuts further boosts bond prices?

Prof. Rowe:
Priya, you’ve captured the essence beautifully. To sum up, fears about tariffs harming the economy prompt investors to seek safety in Treasury bonds. This drives bond prices up and yields down. Concurrently, these economic fears lead investors to expect the Fed will reduce interest rates, making existing higher-rate bonds even more attractive. This combination reinforces the increase in bond prices and the decline in yields, clearly signaling rising economic anxiety.

Alex:
Thank you, Professor Rowe. That makes the dynamics very clear.

Prof. Rowe:
You’re welcome! Great discussion, everyone.