What's going on?

The market for US government bonds has seen relatively large, erratic price movements over the last few months. The market uncertainty is driven by investors realising that interest rates will increase at some point soon. This contrasts to the steady market in 2014, when the US central bank maintained a clear zero interest rate policy.

What does this mean?

Bond markets reflect two core components; the risk of not being repaid and the value of money. For the US government bond market, the former is not really an issue as the US has the ability to print its own currency and investors generally trust that currency. The value of money is initially driven by the central bank interest rate. This rate determines the costs at which banks can borrow, thereby affecting the whole market. But the value of money is also a relative concept between currencies. If an investor can get 1% interest in one currency, but 2% in another, some money will flow from the former to the latter. This increases the currency of the 2% economy until a balance is found. The US economy is currently facing two conflicting trends. On the one hand the economy is doing well, prompting the central bank to consider raising interest rates to prevent the economy from running ahead of itself. On the other hand, money is already flowing into the US from abroad, pushing the US currency up. This, in turn, acts as a break on the US economy by making imports more expensive. The US central bank becomes unsure what to do and how to strike the right balance.

Why should I care?

Bond markets reflect the value of money and hence affect the everyday economic lives we lead. If money becomes cheaper, it becomes easier to borrow which tends to push up investments and consumption. If money is too cheap, however, we may face over-consumption and over-investment. The conflicting trends on the US economy make it difficult for the US central bank to set the appropriate interest rate. Bond markets therefore become hyper-aware to correctly anticipate when interest rates will increase. They pay attention to every data release and central bank announcement for signals about the future. It is difficult for everyday investors to compete with that level of awareness. A better strategy would be to assess the medium- to long-term picture for US growth and US interest rates. In a growing economy, bonds will suffer as interest rates go up. Higher interest rates mean that the old bonds that have lower interest become less attractive. At the end of the day though, this is a relative game, so the important question is where you stand relative to the current market view.