How Key Rate Affects Bond Yields

Last week, October 22, 2021, the Bank of Russia raised its key rate to 7.5%. Now the returns on hedge funds are —

Key rate up — bond price down. Down rate — bond price up. It would seem nothing complicated. However, if you want to understand finance, and not memorize mantras, then it is worthwhile to understand a little about this topic. And we will help.

Key rate

Dynamics of the Central Bank’s key rate and yield to maturity of 10-year government bonds with a zero coupon,%

Obviously, this will be followed by the reaction of the stock market — investors will begin to demand higher yield on bonds, because since the moment the key rate has grown, market conditions have changed, including the main component of the yield of any instrument — the risk-free rate of return on government bonds.

Corporate bond yields are usually higher than government bond yields and

At any given time, a huge number of bonds with different coupon yields are circulating on the market. And if the coupon rate is fixed, then to compensate for the movement of the key rate, the current value of the bond changes.

If interest rates rise, the yield to maturity of current bonds will be lower than that of new issues. This means that the price at which the bonds are traded today will decrease — thus, the price for old issues will “adjust” the future yield, taking into account the increase in the Central Bank rate.

If interest rates in the economy fall, the yield to maturity of new issues will be lower than the yield on bonds that are already in circulation. In this case, the price of already issued bonds will increase so that their yield “equals” the yield of new issues.

This can be done using duration — the sensitivity of a bond to changes in interest rates. The longer the duration, the greater the “reaction” of the security price to the rate change.

The same rules apply for bond ETF investors. ETFs retain the basic properties of bonds by reinvesting any coupon payments received. The investor sees capital gains in the dynamics of the fair value of net assets (NAV). You can read more about bond ETFs in our

It is important to note that the change in the key rate only affects bonds issued in local currency. For example, inside FXRU there are foreign currency bonds of Russian issuers, the ruble interest rate does not directly affect them (the dollar rate does). But on FXRB (the same dollar bonds of Russian issuers, but with a ruble hedge), the increase in the Central Bank rate is reflected, and in contrast to the prices of ruble bonds, positively.

The ruble yield of FXRB, in addition to the actual yield of the foreign exchange bond portfolio, is growing due to the ETF built into this