Duration risk at all-time highs
One of the greatest risks for bond performance is interest-rate risk. As interest rates rise, bond prices fall and vice versa.
Some bonds are more sensitive to interest rates than others and carry more ‘duration risk’, or the risk associated with the sensitivity of a bond or bond portfolio to a one per cent change in interest rates. The higher a bond’s duration, the greater its sensitivity to interest-rate moves.
In Europe, while the ECB announcement means the short end of the yield curve will remain anchored, the potential longer term impacts of the reduction in purchases from Europe’s biggest buyer are yet to be seen.
With this in mind, the hypersensitivity of Europe’s bond markets is also a concern. Small changes to the political or economic environment in Europe tend to generate significant reactions in bond yields. For example, back in June of this year, German 10 year yields rose by 30+ bps off the back of a comment from ECB Chairman Mario Draghi about ‘reflationary forces’ returning to Europe. This lead markets to think that a tapering announcement was imminent. When the announcement did eventually come a few weeks ago, market reaction was muted, but what the June “mini-taper tantrum” does show is how volatile European credit markets can be.
The US however, by way of comparison, is by no means a safe haven. While the Fed has put in place a clear rate hike strategy, questions remain as to the specific timing and magnitude of those hikes, and whether or not long term interest rates will eventually move in tandem.
On top of that, duration-risk remains at all-time highs in both Europe and the US.
And, debate over how and if the Trump administration policy shifts will actually come to pass also continues to influence both credit and general markets in the US.
