Do Record-Low Yields Really Indicate Substantial Duration Risk?

 

Every bond in Japan is yielding less than .4%.  Germany’s ten-year yield is hovering around 25 basis points.  The 10-year U.S. yield is less than the Federal Reserve’s inflation target even though the Fed has begun raising rates off the zero lower bound.  This has led many market commentators to express concern over duration risk—rate-hiking activity from the Federal Reserve (or another other central bank) could mean substantial losses for bond investors.

My money would be on these concerns being over-blown.  As was a well-documented problem (and complaint of central bankers) leading up to the crisis, central banks have less control over the long end of the curve—at least with respect to their adjustments of their short-term policy rates.  Looking at the Fed’s historic hike of the overnight rate in December of last year from the 10-year yield’s point of view: not exactly a skyrocket. (The red line indicates the date of the 2015 hike.)

10Y UST post 2015 hike

In fact, a “surprise” pace of rate-hiking by central banks in the current economic climate would likely be seen as a mistake by markets and excessively hawkish.  This would push long-term yields down as investors deemed it likely that the hikes would slow the economy and the central bank(s) would need to revert back into easing mode; notice the divergent paths of the short and long rates since the Fed began hiking:

10Y UST vs FF 2013-2016

Certainly, duration always represents a risk.  However, I’d say the risks of duration are largely in balance given current economic conditions and market expectations of future interest rates—which do exert direct pressure on the long end of the curve.

A risk?  Yes.  A concern?  Not so much.

5/16/2016 UPDATE: JPMorgan, others now agree with me and note that the Greenspan conundrum (long rates not moving with short ones) is arguably worse now for Yellen.  Deflation forces (excess savings and risk aversion) are global and negative rates in other advanced economies are pushing yield-seekers to long-dated US debt: http://www.bloomberg.com/news/articles/2016-05-16/jpmorgan-joins-chorus-of-banks-cutting-treasury-yield-forecasts

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