Bond market losses are finally over, unless yields exceed 6%

Bond market losses are finally over, unless yields exceed 6%

(Bloomberg) — As brutal as it may be for US bond investors, the scores are finally turning in their favor.

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The latest round of selling has left Bloomberg’s USAgg index’s yield-to-term ratio — a measure of how much yields will need to jump to erase the value of upcoming interest payments — hovering around the highest levels in more than a decade.

This week, that ratio rose to 83 basis points, suggesting that the weighted average return of securities in the benchmark index would need to rise by that amount to create losses large enough to offset the one-year interest rate.

The yield on that index – the broad measure of investment-grade debt – was 5.2% on Tuesday, before easing. That means it would need to jump to around 6% to generate negative returns from here.

Few currently expect yields to rise to this high, even as speculation grows that the Fed will keep monetary policy tight to ensure that inflation does not rise again. As a result, bonds may finally have reached the point where interest payments are large enough to insulate investors from price losses, providing a floor for a market struggling to emerge from the deepest downturn since at least the 1970s.

The ratio in a broad index does not mean that each segment of the market is equally isolated, as it would take a much smaller step to produce losses on longer-dated securities. So negative returns may still appear in some places.

But overall, this is a welcome buffer for investors who have been hit by losses since the Fed started raising interest rates in March 2022.

Prices fell again this month, pushing Treasuries briefly back into the red for the year, due to a confluence of forces, including the resilience of the economy and a flood of new Treasuries sales. The sell-off sent the 10-year Treasury yield to a 16-year high of 4.36% on Tuesday. It traded around 4.25% on Friday after Federal Reserve Chairman Jerome Powell said the central bank was ready to raise interest rates further, if necessary.

“This is a much more attractive return than I’ve been able to get for a long time,” said Thomas Hollenberg, fixed-income portfolio manager at Capital Group, which manages $2.3 trillion in assets. “Longer term, on a hold-to-maturity basis, it’s good value.”

The yield-to-period ratio, which is a measure of reward to risk for investors, has increased steadily as Fed increases have pulled yields off their lowest levels.

At the end of 2021, when yields were just 1.75%, Bloomberg’s duration was 6.8 – meaning that every 100 basis point increase in interest rates would push prices down 6.8%, much more than the value of one-year interest income at 1.75%. the time. By contrast, that measure is now 6.3.

The protection of interest payments is most evident in the shortest-term securities, which actually have the highest returns. It would take a 260 basis point jump in yields to cause 1-3 year debt losses. Much less than that would be needed to bring long-term bonds back into the red: a 29 basis point rise in the Bloomberg Long-Term Treasury Index, which tracks 20- and 30-year bonds, would be enough to offset 12 months of interest income. , according to Bloomberg data.

(Updates with the latest move in the 10-year Treasury yield in the eighth paragraph.)

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