Pristine Trading - Daily Lessons and Picks

[Pristine Trading]

Basics of the Bond Markets

The markets, no matter if you consider only those based in the USA or worldwide, don't act as purely separate entities. The belief that one market is a separate being that's never affected by developments in other markets is a naive idea that doesn't hold water when analyzed from either the technical or the fundamental optic. When money gets out of the US stock markets, it doesn't go beneath the mattresses of traders (no matter what they might say). It will go into other markets, such as the fixed income market (bonds), commodities, or currencies. Thus, a basic comprehension of the way the markets function will allow us to better analyze from a purely technical standpoint the odds of a market moving in a certain direction, and might point to opportunity in certain market sectors. We'll analyze today the bond market and the way they interrelate, and their repercussions in the process of price formation in the stock market.

The bond market that we'll refer to is the US Treasury Bond market. US treasury bonds are issued by the US Government to finance its diverse expenditures. These bonds are "zero coupon". This means that they don't pay a regular quarterly interest "coupon". Instead, they are placed at a "discount" to their face value. Suppose for simplicity reasons that the US Treasury was placing a one year "bond" that would yield 3% at expiration. In order to "pay" the interest rate, the treasury will place a $1,000 bond (face value) at a price of $970. Then, at the expiration date (1 year), it would redeem the bond for its face value. Thus, the holder would receive $30 additional to what it paid for the bond, which would equal a yield of 3%. From this explanation, we conclude that the yield to price relation of these bonds is an inverse one. When the prices of these bonds rise (more demand than supply), yields decline and vice versa. Traders often look at specific expirations, for clues as to the market's expectations in regards to interest rates, and as a way to analyze the flows of funds in this market. The most popular expirations for traders purposes are the 10 Year Bond (Realtick® symbol is $TNX.X) and the 30 year ($TYX.X).

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