Lessons from Changes in Bond Yield

In the last 1-2 weeks, there were several news related to Bond Yield that I noticed increasingly getting media attention. For example 2 latest news:

  • Cash News April 17, 2012 – SUN Auctions, investors are predicted to be high yield
  • Detik Finance News 17 April 2012 – Spanish Bond Yield Breaks 6%, European Crisis Back Heats

What is the effect of this yield change on investment, especially mutual fund investments? The two news above are one very practical example in applying the knowledge of bonds that we have learned before.

In the first Kontan news mentioned ” the 10-year FR0061 series, the price also fell by 96 bps to 106.25 with a yield of 6.15 “. To find out why bonds with 10-year tenors are used, you can read this article.

Bonds

Bonds

In bonds known as the theory of the relationship between price and interest rates as follows ” if the interest rate rises then the bond price will go down and vice versa if the interest rate falls, the bond price will rise.” Along with market dynamics, intervention, and foreign influences not only looking at domestic factors but also globally, the above theory has begun to lag somewhat behind. To respond to market dynamics as they are now, bond theory should be changed as follows:

“If the YIELD Bond is EXPECTED, it will RISE, then the bond PRICE will DOWN, otherwise if the YIELD DIEXPECTED bond will DOWN, then the bond PRICE will RIDE”

In an age where change is very dynamic and almost happens every day, changes in interest rates have sometimes been reflected long ago from changes in bond yields. In addition, several times in the history of the Indonesian capital market, bond prices experienced significant changes even though interest rates tended to be flat. Expectations for interest rates are the main drivers in the market.

If the market believes the interest rate will rise, the bonds will be transacted at a higher yield so that the bond price will fall. Changes in interest rates themselves may only occur a few months later, it could turn out to be different from market expectations. JADI, in seeing / predicting the performance of bond-based mutual funds, it is very important for investors / Investment Managers to be able to predict changes in Bond Yield.

Return to the Increase in Indonesian Bond Yield where the 10-year Yield reaches 6.15% (previously below 6%), this indicates that the market expects that the yield will rise. In accordance with the theory that I have put forward, the increase in yield will cause a decrease in bond prices and a decrease in bond prices will cause a decrease in the price of fixed income mutual funds and mixed bonds.

One of the reasons for the increase in Yield expectations from the domestic side is, among other things, the limitation of fuel policy which is planned to be implemented in May on a limited basis. With the limitation of fuel, it is estimated that it will cause an increase in the inflation rate even though the effect is not as big as the increase in fuel prices directly. The expectation of this inflation increase, by the market, was responded to by the yield increase. Not to mention, the threat of rising inflation also comes from the factor of rising food prices and staples that have been raised before the increase in fuel prices.

From the foreign side, the rise in Indonesian yield expectations is also due to the rising debt crisis in Europe. Spain is now predicted to be one of the countries that will be the source of the next crisis due to fiscal stability and high unemployment rates. However, generally the effects of the crisis occurring abroad especially in Europe have an inconsistent effect on the Indonesian bond market. The proof is that when the crisis occurred in Portugal, the price of our bonds continued to rise. Likewise, when the crisis hit Greece, the Indonesian stock market had indeed been affected, but the bond market continued to soar to beat the performance of equity mutual funds in 2011. So, we really cannot rule out the crisis in Spain and Europe, but in responding to the market Indonesian bonds, investors need to focus more on fundamental factors and come from domestic factors such as inflation and interest rate policies.

From the above facts, it can be seen that a country is said to be moderate or the crisis turns out to be known from the amount of the Bond Yield. As a reference, the real emergency number for countries in Europe is when the 10-year yield exceeds 7%. Because when Yield passes that number, it means that the cost needed for a country to obtain a new loan is 7%. This figure is considered too high by some countries where Ireland and Portugal immediately asked for assistance to the IMF when it reached that number.

From the 2 news about the bonds above, I hope we can learn that:

From the 2 news about the bonds above, I hope we can learn that:

  1. Changes in yield can predict changes in interest rates that will occur in the future
  2. Yield changes can cause an increase or decrease in prices on bond-based mutual funds
  3. Change in yield can find out whether a country is in a crisis or not

Thus sharing this article, hopefully it can benefit you all.

The mention of investment products (if any) does not mean to give a good bad rating, or a recommendation to buy or hold for certain instruments. The purpose of giving an example is to show facts that reinforce the opinion of the writer. Past Performance is not a guarantee that it will repeat itself in the future. All posts, comments and responses to comments are personal opinions.