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Overview
Duration is a key vulnerability for bond investors. Duration is a measure of how sensitive the price of a bond is to changes in interest rates. The higher the duration, the more sensitive.
As the chart shows, the highly rated AA bonds have a higher duration than the lowly rated A and BBB.
But there’s still a lot of demand, not least from foreign buyers, and it’s hard to shake the market’s faith that the US Federal Reserve has its back.
That could mean tighter before wider spreads.
Chart 9: Highest rated US corporate bonds most exposed to higher interest rates (duration (years))
Source: Bloomberg
Investors will be spending the next six weeks or so looking forward to the RBA’s July meeting and striving to work out whether the central bank will adjust its settings. Lowe said two weeks ago the RBA would decide in July whether to extend its QE program past September, and also whether to roll over the three-year yield target maturity to the November 2024 bond from the current April 2024.
Deputy Governor Guy Debelle said that these decisions will be guided by both domestic and international factors, indicating wage pressures and labour tightness will be key determinants. An unemployment rate around 4.0% is seen to be needed to get inflation up into the RBA’s 2-3% target range. Currently the unemployment rate is 5.5%.
Chart 10: RBA Balance Sheet ($b)
Source: Bloomberg
Economic reports are verging on all noise and no signal thanks to the distortions caused by the pandemic’s sudden impact just over a year ago.
The US Fed is among central banks that are busy looking through conventional data such as transitory inflation. Investors were already facing challenges judging how central banks will act, and now there are all kinds of “funny numbers” pouring out of economic reports like South Korean 20-day exports to the U.S. rising almost 90% y/y, New Zealand house sales soaring more than 400%, or the U.S. core CPI rising at the fastest pace since the 1980s.
The temptation, especially with plenty of stimulus still pouring in, would be to look past the data for now. The key for investors is when to start restoring data to its previous weight in their decision-making processes.
Chart 11: Japan, EU and US central bank bond ownership (% total outstanding bonds)
Source: Bloomberg
