Bonds: Fear and optimism drive bond prices

— -- Q: What makes bond prices go up?

A: In a word: demand. The same thing that makes the price of anything go up.

It might sound simplistic, but when investors start buying bonds, that drives up bond prices. Just as when investors scramble to buy a stock, they push up the stock's price.

Now, to the heart of your question: Why would investors buy bonds? That depends in part on the type of bonds you're talking about. If you see prices of debt issued by the U.S. government, called Treasuries, rise, that's a sign investors are looking for safety. Treasuries generally carry low yields relative to other bonds because they're viewed as a less risky place to stash cash. Remember: To get potentially higher rewards, you have to take higher risk.

So, when the prices of Treasuries rise, as they did during the financial meltdown last fall, that's generally a sign investors are fearful of putting their money elsewhere. In some cases, they were willing to accept no interest at all in return for that safety. As you may know, bond yields fall when prices rise.

By contrast, when you see the prices of debt issued by companies with low credit ratings rise, that's a sign investors are bullish about the economy. So-called junk bonds typically have high yields to compensate investors for the added risk.

There are also other factors that move demand for bonds. Inflation, for example. When investors fear inflation will be a problem, they tend to avoid long-term bonds. Inflation fear can cause demand, and prices, for all bonds to fall. For instance, a bond paying a 4% yield for 10 years won't look so good if inflation soars to 10%. As a result, the price of the bond falls.

These are just two examples of what causes bond prices to move. If you're interested in learning more about why bond prices go up and down, the Securities Industry and Financial Markets Association maintains a helpful site called InvestingInBonds.com.