Why do bond yields climb or fall while the coupon stays the same?

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OpenQ : 4

Why do bond yields climb or fall while the coupon stays the same?

On October 20 the yield on France’s ten-year government bond briefly touched 4.99%. Every French bond already in circulation kept paying the same coupon it paid the day before. The coupon and the yield measure different things, and the gap between them explains most of what happens in a bond market.

The coupon is fixed on the day a bond is sold. A government borrows €100, promises to pay €3 a year and promises to repay the €100 on a set date. That 3% coupon never changes. The bond then trades between investors for years, and its price moves every day.

Take that 3% bond with nine years left to run. New bonds now pay 5%. Nobody will pay €100 for €3 a year when a new bond pays €5 for the same money. Sellers must cut the price until a buyer earns about 5%. At roughly €86, the buyer collects €3 a year and gains €14 when the government repays €100 at maturity. Together those two pieces return about 5% a year.

That return is the yield. It is what a buyer earns if he pays today’s price and holds the bond to the end. When prices fall, yields rise. When prices rise, yields fall. The coupon stays where it was.

Several forces move the price. Central banks set short-term interest rates, and long bonds follow them in part. Expected inflation erodes the value of fixed payments, so lenders demand more when they expect prices to rise. Supply matters too. France plans to sell €340 billion of bonds in 2027, and buyers want a better price to absorb that much. Doubt about a borrower adds a premium, which is why France pays more than Germany.

Long bonds move more than short ones. A bond with thirty years of fixed payments loses more value when yields rise than a bond that repays next year. Silicon Valley Bank held long-dated Treasuries bought when yields were low. When yields rose in 2022 and depositors withdrew money in 2023, the bank had to sell those bonds at a loss, and it failed.

For a government the old coupons are settled. The new ones are not. Each bond that matures must be replaced, and the new bond must carry a coupon close to today’s yield. A rise in yields reaches the budget slowly, but it reaches it.

The OpenQ

Central banks control short-term rates, but the market sets long-term yields. The two can move apart. A central bank can cut its rate while lenders demand more to hold ten- or thirty-year debt. The open question is how much control any central bank still has over what governments, companies and homebuyers pay to borrow for the long term.

Think About

A pensioner buys a French bond with a 3% coupon and holds it to maturity. She receives every euro she was promised, but for years her statement shows a loss. Did she lose money?

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