The way bond math works, the lower the interest rate on a bond, the higher the price sensitivity for a change in interest rates, either up or down. That sensitivity is known as duration, and with rates on trillions of bonds in negative territory, duration is at an all time high. So too, then, is the downside risk of owning bonds. From Tyler Durden at zerohedge.com (see also The Biggest Short on SLL):
Yields on $7.8 trillion of government bonds have been driven below zero by worries over global growth, forcing investors looking for income to flood into debt with maturities of as long as 100 years. Worse still, as Bloomberg reports, central banks’ policy is exacerbating matters, as the unprecedented debt purchases to spur their economies have soaked up supply and left would-be buyers with few options. This has driven the ‘duration’ – or risk sensitivity – of the bond market to a record high, meaning, as one CIO exclaimed, even with a small increase in rates “the positions are so huge that the damage can be massive… People are complacent.”
Decelerating economic growth worldwide, combined with more aggressive stimulus measures by the Bank of Japan and the European Central Bank, pushed average yields on $48 trillion of debt securities in the BofA Merrill Lynch Global Broad Market Index to a record-low 1.29 percent this month, compared with 1.38 percent currently.
Such low yields are unnerving some of the most famous names in the bond market.
Gross, who runs the $1.3 billion Janus Global Unconstrained Bond Fund, said in a recent tweet that a tiny move in Japanese 30-year government bonds could wipe “out an entire year’s income.”
It won’t take much of a backup to inflict outsize losses.
The effective duration of the global bond market, which is measured in years and determines how much prices are likely to change when interest rates move, surged to an all-time high of 6.84 years in April.
That translates into a 6.84 percent decline in price for every percentage-point increase in yields.
Simply put, a half-percentage point increase would result in a loss of about $1.6 trillion in the global bond market, according to calculations based on data compiled by Bank of America Corp.
This year alone, the danger of owning debt has surged by the most since 2010, raising concerns from heavyweights such as Bill Gross. It’s also left some of the world’s biggest bond funds, including BlackRock Inc. and Allianz Global Investors, at odds over the benefits of buying longer-dated bonds.
“It takes a fairly small move out in rates on the long-end to wipe out your annual return,” said Thomas Wacker, the head of credit of the Chief Investment Office at UBS Wealth Management, which oversees $2 trillion in assets. Longer-maturity debt is “not something we are particularly keen on,” he said.
To continue reading: “The Damage Could Be Massive” – How Central Banks Trapped The World In Bonds