A bond is a loan you can trade. You hand over cash today, collect fixed interest along the way, and get your principal back at the end. Everything sophisticated about rates is just bookkeeping on that one sentence.
3.1Why do bond prices and yields move in opposite directions?
A bond pays fixed cash flows: a coupon (the interest) and the face value (par, usually $100 or $1,000) at maturity. The yield is the return you actually earn given the price you pay. Here's the key: the cash flows are fixed, so the only thing that can move to reflect new market rates is the price.
If you own a bond paying a 3% coupon and new bonds suddenly pay 5%, nobody wants your 3% bond at full price — so its price falls until its yield matches the new 5% world. Rates up → existing bond prices down. Rates down → prices up. Always.
A bond with a $3 annual coupon (3% of $100 par):
Market rates rise; price falls to $94 → yield = 3 ÷ 94 = 3.19%
Market rates fall; price rises to $107 → yield = 3 ÷ 107 = 2.80%
(Full yield to maturity also accounts for the pull-to-par of the principal, but the inverse relationship is identical and this is the intuition that matters.)
3.2Duration & convexity — how much will the price move?
Duration answers "if yields move 1%, how much does my bond's price move?" The longer until you get your money back, the more sensitive the price — a 30-year bond is far more rate-sensitive than a 2-year note. This is why "long-duration assets" (long bonds, but also high-growth tech stocks whose value is far in the future) get hit hardest when rates rise.
A bond with modified duration 8, yields rise +0.50% (50 basis points):
So 8 years of duration turns a half-point yield rise into a 4% capital loss. Flip the sign for a yield fall: −8 × (−0.50%) = +4.0%. Duration is the bond market's leverage dial.
DV01 ("dollar value of a basis point") is the same idea in cash: how many dollars you gain or lose per 0.01% yield move. Desks risk-manage entire bond books in DV01 terms. Convexity is the second-order correction — because the price–yield line is actually a curve, duration alone slightly under- or over-states big moves; convexity is generally a friend to the bondholder.
3.3The yield curve — the market's most-watched chart
Plot yields against maturity (2y, 5y, 10y, 30y) and you get the yield curve. Its shape is a real-time read on growth and policy.
- Normal (upward): longer bonds yield more — investors demand extra for tying up money longer. The healthy default.
- Flat: short and long yields converge — the market is uncertain or the cycle is turning.
- Inverted (downward): short yields exceed long yields. Historically one of the most reliable recession warnings — it says the market expects the Fed to cut rates in future because growth will weaken.
Traders track spreads between points (the 2s10s = 10y yield − 2y yield is the famous one). A steepener bets the curve steepens; a flattener bets it flattens. These can be "bull" (driven by falling yields) or "bear" (rising yields) — four combinations, each with a different macro story.
3.4The Fed & the front end
The central bank sets the very short-term rate (the Fed Funds target in the US). That anchors the front end of the curve; the long end is set by the market's expectations for growth, inflation and future policy. So the front end is about the Fed now, the long end about the economy later.
You can trade pure expectations of Fed policy with SOFR futures (SR3, three-month rates) and Fed Funds futures (ZQ), whose prices imply the probability of hikes and cuts at each meeting. When you read "the market is pricing a 70% chance of a cut", that number comes straight from these contracts.
3.5How do you trade rates? Futures and ETFs
The US Treasury futures complex is one of the deepest markets anywhere, with a contract for each part of the curve.
| Maturity | Future | ETF | Use |
|---|---|---|---|
| 2-year note | ZT | SHY | Front-end / Fed expectations |
| 5-year note | ZF | IEI | Belly of the curve |
| 10-year note | ZN | IEF | The global benchmark rate |
| 30-year bond | ZB / UB | TLT | Long duration, max rate sensitivity |
TLT (20+ year Treasuries) is the retail favourite for a big rates view because its long duration makes it move a lot — which cuts both ways. Inverse and leveraged rate ETFs (e.g. TBT) exist but carry the same daily-reset decay covered in Part 1.5.
A Treasury future can be settled by delivering any of several eligible bonds, so its price tracks the cheapest-to-deliver (CTD) bond, and its effective duration shifts as the CTD changes. For directional trades this rarely matters; for precise hedging and basis trades it's everything. It's also why "the 10-year future" doesn't map exactly to "the on-the-run 10-year note". File it away; it separates the rates specialists from the tourists.
3.6Global government bonds & credit
Every major economy has its sovereign curve: Bunds (Germany, the eurozone benchmark), Gilts (UK), JGBs (Japan), OATs (France), BTPs (Italy). Spreads between them — say BTP–Bund — measure perceived credit and political risk within the euro area.
Beyond governments sits credit: investment-grade and high-yield ("junk") corporate bonds. The extra yield they pay over Treasuries is the credit spread, and it's a premier risk gauge — spreads widen when investors fear defaults, often before equities crack. Trade it via LQD (investment grade) and HYG/JNK (high yield), or CDS indices at the institutional level.
The US Treasury market alone is roughly $27–28 trillion outstanding, and the global bond market dwarfs global equities at well over $130 trillion. This is the market — when people say "the bond market vigilantes", they're talking about a force larger than any stock market on earth. Verify current figures with SIFMA / the US Treasury.
3.7What moves bonds? (Including your CPI example)
Start with the simple, high-frequency relationships, then the second-order ones that catch people out.
| Catalyst | Simple reaction | The non-obvious second-order |
|---|---|---|
| CPI higher than expected | Inflation hot → Fed stays/gets tighter → bond prices fall, yields rise | If the market reads it as peak inflation that forces the Fed to over-tighten into a recession, the long end can rally (yields fall) even as the front end sells off — a bull flattener. The same print can push 2y and 30y in opposite directions. |
| CPI lower than expected | Bond prices rise, yields fall (Fed can ease) | A too-cold print can flip to risk-off if it signals demand is collapsing — then govvies rally on growth fear, not just on the rate path. |
| Strong jobs / GDP | Yields up (less need to cut) | Late cycle, strong data can steepen the curve as term premium rebuilds — the long end sells off more than the front. |
| Fed hikes / hawkish | Front-end yields up | An aggressive hike can lower long yields if it convinces the market inflation will be crushed — policy credibility flattens the curve. |
| Risk-off / equity crash | Treasuries rally (flight to safety), yields fall | Breaks down when the shock is the bond market (2022, 2013 taper, UK gilt crisis 2022): then stocks and bonds fall together and the safe-haven bid vanishes. |
| Huge Treasury supply / weak auction | Yields up (more bonds to absorb) | Supply and "fiscal" risk now move the long end independently of the Fed — a structural shift traders ignored for a decade. |
Beginners sometimes treat "bond prices" and "yields" as two separate things that might disagree. They can't — they're two ends of the same see-saw. When you read a headline like "CPI hot, bonds sell off", that is yields rising. The genuinely hard part isn't the direction on a single maturity; it's that a catalyst can hit the front and the long end differently, reshaping the whole curve. The veteran's question after any data print isn't "up or down?" but "which part of the curve, and does the curve steepen or flatten?"