Inflation and bond yields have a direct relationship. When inflation rises, bond yields usually go up. This happens because investors want higher returns to make up for the loss of purchasing power caused by inflation. So, to attract buyers, bonds must offer higher yields when inflation is high.
Why Do Bond Yields Rise When Inflation Increases?
When inflation goes up, the money you get from bonds in the future is worth less in real terms. Investors know this and demand higher yields to compensate for the decreased value. This means bond prices fall as yields rise because bonds with fixed payments become less attractive during inflation.
Central banks may also raise interest rates to control inflation, which pushes bond yields higher.
How Inflation Affects Different Types of Bonds?
Fixed-rate bonds are more sensitive to inflation because their interest payments stay the same even if inflation rises. This reduces their real returns. Inflation-indexed bonds, like India’s Inflation-Indexed National Savings Securities (IINSS), adjust payouts based on inflation, protecting investors better.
Shorter-term bonds tend to be less affected by inflation than long-term bonds because the money is returned sooner.
What Happens to Bond Prices When Yields Rise?
Bond prices move opposite to yields. When inflation pushes yields higher, bond prices fall. This happens because newer bonds offer better returns, so older bonds with lower yields become less valuable. This price drop can cause losses for investors who sell bonds before maturity.
Understanding this helps investors decide when to buy or sell bonds during inflation changes.
How Do Central Banks Influence Bond Yields During Inflation?
Central banks raise interest rates to fight high inflation. When rates rise, new bonds offer higher yields, which pushes existing bond prices down. This raises overall bond yields in the market. Investors watch central bank policies closely because these affect bond returns and investment decisions.
This connection is important for investors to understand changes in bond market trends.
How Can Indian Investors Manage Inflation Risks in Bonds?
Indian investors can manage inflation risks by diversifying bond investments. Adding inflation-indexed bonds, short-term debt funds, or corporate bonds can reduce impact. Also, holding bonds till maturity avoids price losses due to yield changes. Regularly reviewing bond portfolio helps keep up with inflation trends.
Proper planning can help maintain steady income even during inflation.
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