Predictive power of the bond market
How strong is the predictive power?
The bond market has a strong correlation with the overall economy, serving as a key indicator of economic conditions and future trends. Here's how the bond market relates to various economic factors:
Inflation
Inflation expectations significantly impact bond yields. Bond yields and inflation have a strong, positive relationship. As inflation rises, bond yields typically increase as well. This relationship is driven by several key factors:
Real Returns: The real return on a bond (nominal yield minus inflation rate) decreases as inflation rises.
Purchasing Power Erosion: Higher inflation reduces the future purchasing power of a bond's fixed interest payments and principal, making existing bonds less attractive.
Investor Compensation: To offset the negative impact of inflation, investors demand higher yields on new bonds, pushing yields up across the market.
Central Bank Policy: When inflation rises, central banks often increase interest rates to cool the economy. This leads to higher yields …