What happens to the price of a bond if the Federal Reserve raises interest rates?

When the Federal Reserve raises interest rates, existing bonds that were issued with lower rates become less attractive to investors. This is because the new bonds issued will offer higher yields due to the increased interest rates. As a result, the market price of existing bonds must fall for their yields to rise to a level that is competitive with the newly issued bonds.

This adjustment occurs because the bond’s yield is inversely related to its price. If the price of existing bonds decreases, the yield rises, making them more appealing to investors compared to new bonds with higher interest rates. In essence, lowering the price of existing bonds allows their yield to increase, attracting buyers who might otherwise prefer the new, higher-yielding options. Thus, the dynamic between interest rates and bond prices illustrates the fundamental principle of the bond market where price and yield move in opposite directions in response to changes in interest rates.