Hi All,
Re: the FOMC announcement today, the market is almost 100% expecting a hike, causing a drop in treasury yields (http://www.marketwatch.com/story/treasury-yields-drop-as-investors-brace-for-fed-rate-hike-2016-12-14).
I’m trying to understand the rationale for the decreased yields, given the rate hike. Admittedly, my understanding of fixed income is not as strong as I’d like it to be but I want to learn and am throwing the question out to the community. Any help would be great.
My thought process is as follows: - A very raw form of calculating yield is coupon rate/market price of bond (assuming flat rate curve). A drop in yield would imply that either coupons have gone down or market price of bond has gone up
Based on the behaviour today, investors are excessively buying treasuries today, drives up the price >>> increases denominator >>> decreases yield.
But just thinking out loud: - Since the rate curve has been adjusted up i.e. future cash flows are being discounted at successfully higher rates, reducing PV of cash flows (reducing the current value/price >>> shouldn’t this be increasing yield based on my simple fraction above) or,
- Using the YTM angle, since current treasury coupons will now be invested at higher interest rates after the hike, shouldn’t this increase the yields of current bonds or,
Again, my explanations above may be very “by-the-book”. But any help is appreciated on the last 2 questions - or any other comments on my guess of lower yields above.