Bond Yield & Price: Why They Move in Opposite Directions

Why Bond Prices and Yields Move in Opposite Directions

A bond is a fixed-income stream. When you buy a bond, you lock in a fixed coupon payment (the interest rate paid on the face value). If market interest rates rise after you buy, new bonds are issued with higher coupon rates. Your existing bond with its lower coupon becomes less attractive to buyers, so its price must fall to offer a competitive yield. Conversely, if market rates fall, your bond's fixed coupon becomes more attractive, and its price rises. The price adjusts until the bond's yield matches the prevailing market rate for bonds of similar risk and maturity. This repricing happens continuously in the secondary bond market. If you hold a bond to maturity, you receive your full principal back regardless of interim price fluctuations — assuming the borrower does not default. Learn about Treasury securities →

Worked Example: The Inverse Relationship

You buy a 10-year bond at par ($1,000) with a 4% coupon that pays $40 per year in interest. Market rates then rise to 5%. New bonds now pay $50 per year for the same $1,000 investment. Your bond still pays only $40 per year. To compete, your bond's price drops to approximately $920. At this price, the $40 coupon gives a 4.35% current yield ($40/$920), and the discounted principal at maturity adjusts the yield to maturity (YTM) to the market rate of 5%. The exact price depends on the remaining time to maturity — the longer the remaining term, the more the price must adjust. This is the core mechanism behind all bond price movements. Compare government and corporate bond yields →

Duration: Measuring Interest Rate Sensitivity

Duration measures how sensitive a bond's price is to changes in interest rates. It is expressed in years, and it approximates the percentage change in price for a 1% change in yield. For example, a bond with a duration of 5 years will fall in price by approximately 5% when interest rates rise by 1%, and rise by approximately 5% when rates fall by 1%. Modified duration is the precise calculation: if duration is 7 and rates rise by 0.5%, the bond price falls by approximately 3.5% (7 × 0.5% = 3.5%). Longer-term bonds have higher duration and are therefore more sensitive to rate changes. A 30-year Treasury bond has duration of roughly 15-20 years, making it far more volatile than a 2-year Treasury note with duration under 2 years. Zero-coupon bonds have the highest duration because all cash flows come at maturity. Bond ETFs display their average duration — check this number to understand your interest rate risk. Compare bond ETFs with individual bonds →

The Yield Curve: What It Tells You About the Economy

The yield curve plots interest rates across different maturities, from 3-month Treasury bills to 30-year Treasury bonds. A normal yield curve slopes upward — longer maturities pay higher yields because investors demand compensation for the risk of holding bonds longer. An inverted yield curve occurs when short-term yields are higher than long-term yields. This has historically been one of the most reliable recession predictors — every US recession since the 1950s has been preceded by an inverted yield curve. A steepening curve (long rates rising faster than short rates) signals expectations of economic expansion. A flattening curve (long rates falling relative to short rates) signals a slowing economy. Central banks use the yield curve to gauge market expectations and set monetary policy. Compare brokers for bond trading →

Why do bond prices fall when interest rates rise?

Bond prices fall because existing bonds with fixed coupons become less attractive compared to new bonds paying higher coupons. The price adjusts downward until the bond's yield matches current market rates. Think of it as a mathematical necessity: if market yields rise from 4% to 5%, a bond paying $40/year must drop in price so that $40 represents a 5% yield on the new purchase price ($40/$800 = 5%). This price adjustment protects the buyer who purchases at the new price, while the original owner experiences a capital loss if they sell early. The longer the bond's remaining maturity, the more the price must adjust.

What is a good duration for my bond portfolio?

The right duration depends on your investment horizon and risk tolerance. If you need the money in 2-3 years, stick with short-duration bonds (duration under 3) to minimize price volatility. If you are investing for 10+ years and can tolerate interim price swings, intermediate to long duration (5-15) offers higher yields and more price appreciation when rates fall. A common rule of thumb: match your bond portfolio's duration to your investment horizon. If you will need the money in 5 years, a duration of 4-5 years is reasonable. For retirees relying on bond income, a ladder of bonds with staggered maturities provides regular cash flows while managing interest rate risk.

What does an inverted yield curve mean?

An inverted yield curve — where short-term rates are higher than long-term rates — has preceded every US recession since the 1950s. It signals that investors expect economic growth to slow and central banks to cut interest rates in the future. Banks borrow at short-term rates and lend at long-term rates; when the curve inverts, lending becomes less profitable and credit tightens. However, the lag between inversion and recession varies widely — from 6 months to over 2 years. An inverted curve does not guarantee a recession, but it is a strong warning sign that investors take seriously. As of 2024-2025, the yield curve has been inverted for an unusually long period, sparking ongoing debate about whether this time is different.

Should I buy bonds when interest rates are high?

Yes, buying bonds when rates are high can be an excellent strategy. You lock in attractive yields, and if rates subsequently fall, your bond's price will rise — giving you both interest income and capital appreciation. This is called total return. The risk is that rates continue to rise, causing temporary price declines. A bond ladder — buying bonds with maturities of 1, 3, 5, 7, and 10 years — helps manage this risk by allowing you to reinvest maturing bonds at higher rates if rates keep rising. In a high-rate environment, short-to-intermediate duration bonds offer the best risk-reward balance because they lock in good yields with less price volatility. Consider a combination of Treasuries and investment-grade corporate bonds for diversification.

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