“Understanding Government Bond Prices and Yields in an Era of Rising Interest Rates – Analysis and Strategy”

But how and to what extent do government bond and bond prices and yields move? In an era of rising interest rates it is good to do some reasoning. And write some numbers. In the table we have shown the effect of the fluctuations on the different maturities of the BTPs. Starting with a two-year term, going through five other maturities, ending with the longest-lasting of the securities placed by the Italian Treasury, the issue which will be redeemed on 1 March 2072. The coupon flow of the securities shown in the table is far from univocal, because it represents the cost of money established for each individual issue, on the date on which the initial placement took place. In fact, it is well known that every single maturity is re-proposed to investors on several occasions, so that the outstanding nominal value is relevant. And such, above all, as to attract the interest not only of Italian investors, but of international ones. The presence of the Italian Treasury on the primary market, the one dedicated to the issuance of new securities, is constant, in light of both the repayment of maturing securities and the payment of coupons

The bills

The table shows the changes in market prices, as yields decrease or increase. The change is one point. In fact, the ECB’s key rate now stands at 3.50%, having been stuck at zero until July 27 last year, when it rose to 0.50%. As it can easily be seen that the rise in the reference rate was very rapid, albeit decidedly slower than that of the similar official rate in the United States or the United Kingdom. Such a situation, which repeats itself quite often over a medium-long period of time, is the reason which leads to investing in instruments both with a medium-short duration and with a longer maturity, depending on the personal propensity for risk, or according to the duration with which you intend to manage your personal securities portfolio.

The ideal strategy is the one that divides the portfolio itself, implementing a diversification between maturities, but nothing prevents you from dedicating yourself, as occurs in situations of greater uncertainty, to short-term investments, in the awareness that the profitability produced will not be of a high level and, often, lower than the rate of inflation which characterizes the economic phase in which the country is experiencing. With reference to the current domestic and international situation, the prospect is a gradual return of the cost of living to gradually declining levels. Bringing the inflation rate back to 2% will still take time, but already within a year or so the current value will have significantly decreased.

The work of the ECB

Indeed, the continuous rate hike by the ECB will produce an increase in the costs of production and consumer goods. It cannot be ruled out that economic growth may undergo a slowdown, albeit a rather limited one, and that to bring the level of consumption back up again, retail prices will have to decrease. It has been indicated on several occasions that, in the aforementioned period of approximately twelve to eighteen months, market yields could decrease significantly, thanks to a further drop in production costs, and consequently in retail prices, because © the price of raw materials will drop more and more. As can be seen from reading the table, managing the bond sector, even with the presence of ten-year issues, could benefit from an increase of about eight points, compared to the current quotation, when the market yield will drop by one point, compared to today’s.