Treasury yield levels are overwhelmingly a function of inflation. However, in the short run, a plethora of influences can explain deviations between yields and inflation. These factors, which we call noise, are significant for short-term traders but can hide tremendous opportunities for long-term investors.
As we witness, bond market noise can be deafening. The horror-ridden narratives explaining the sudden rise in yields are compelling. They can steer even the best traders away from a golden opportunity.
For those bullish on bonds, separating the noise from the signal is difficult. But, doing so allows you to alleviate short-term stress when bond prices move adversely. Additionally, it helps maintain confidence in long-term fundamental prognostications.
This article discusses one of our favored bond fair value models to show you the true bond yield signal.
The signal is the meaningful information that you’re actually trying to detect. The noise is the random, unwanted variation or fluctuation that interferes with the signal. – Conceptually
Market noise is the primary determinant of hour-to-hour and day-to-day price changes. While it is very important for short-term direction, its influence often wanes quickly.
Today, there are a plethora of concerning narratives explaining why bond yields are rising. At first glance, they make a lot of sense and should be worrying. However, if you take the time to research them, you will find many recent bond market narratives are insignificant temporary noise.
Noise can be separated into real noise and false narratives.
Real noise are influences that changes the demand and or supply of bonds.
For instance, risk premium describes investors’ preferences for longer-maturity bonds versus
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