Bond Market Losses Are Finally Over, Unless Yields Blow Past 6%

As brutal as it’s been for US bond investors, the math is finally turning in their favor.

(Bloomberg) — As brutal as it’s been for US bond investors, the math is finally turning in their favor. 

The recent round of selling has left the Bloomberg USAgg Index’s yield-to-duration ratio — a measure of how much yields would need to jump to wipe out the value of coming interest payments — hovering around the highest levels in over a decade. 

This week, that ratio rose to 83 basis points, indicating the average-weighted yield of the securities in the benchmark would need to rise by that amount to create losses large enough to offset one year’s worth of interest. 

The yield on that index — broad gauge of investment-grade debt — hit 5.2% Tuesday, before pulling back. That means it would need to jump to around 6% to produce negative returns from here. 

Few are currently expecting yields to climb that high, even with speculation mounting that the Federal Reserve will hold monetary policy tight to ensure inflation doesn’t pick up again. As a result, bonds may have finally reached the point where interest payments are large enough to insulate investors from price losses, providing a floor for a market that’s struggling to emerge from the deepest downturn since at least the 1970s. 

The ratio in the broad index doesn’t mean every segment of the market is equally insulated, since it would still take a much smaller move to produce losses on the longest-dated securities. So negative returns may continue to crop up in places.

But overall, it’s a welcome buffer for investors who have been hammered by losses since the Fed started raising rates in March 2022. 

Prices slid again this month, driving Treasuries briefly back into the red for the year, due to a confluence of forces, including the economy’s resilience and a deluge of new Treasury sales. The selloff sent 10-year Treasury yields to a 16-year high of 4.36% on Tuesday. They traded at around 4.25% on Friday after Fed Chair Jerome Powell said the central bank is prepared to raise interest rates further, if needed.

“That’s a much more attractive yield than you’ve been able get for a long time,” said Thomas Hollenberg, a fixed-income portfolio manager at Capital Group, which manages $2.3 trillion in assets. “On a long term, hold-to-maturity basis, that presents good value.”

The yield-to-duration ratio, which amounts to a reward-to-risk measure for investors, has increased steadily as the Fed’s hikes pulled yields off rock-bottom lows. 

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

The cushion provided by interest payments is most apparent in the shortest-dated securities, which already have the highest yields. It would take a 260 basis-point jump in yields to result in losses for 1-3 year debt. Much less would be needed to put longer-term bonds back in the red: A 29 basis-points rise in the Bloomberg long-term Treasury index, which tracks 20- and 30-year bonds, would be enough offset 12 months of interest income, according to Bloomberg data. 


(Updates with latest 10-year Treasury yield move in 8th paragraph.)

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