The danger lurks in global markets paralyzed by rising bond yields

Just as an all-out boost drives records on the S&P 500 and inflates risky assets, the bond market is sending a warning signal to investors that a rapid economic recovery comes with its own dangers.

Treasury yields jumped to the highest level since the early days of the pandemic, with the launch of the vaccine and the potential for another US stimulus package resuscitation animal spirits and the prospect of inflation. But years of almost zero rates and a Excessive historical debt has left stocks and bonds especially vulnerable to deep losses if yields soar as growth slows.

The risk centers on duration, now close to a record high, as debt issuers around the world tilt sales to longer maturities and coupon payments plummet or evaporate completely. Trillions of dollars are at stake, given the high levels of stocks and bonds – and some fear a repeat of the 2013 rage, when then Fed Chairman Ben Bernanke sparked an increase in yields after suggesting that the central bank could start cutting active purchases.

“There is more risk of duration built into the markets than many can imagine,” said Gene Tannuzzo, portfolio manager at Columbia Threadneedle.

As security duration measures flirt with the records, investors can expect greater losses with higher yields. It is a risk that has wider repercussions, as many stock watchers warn that stocks are not immune, and technology darlings are particularly exposed.

Some pain is already on display. After two years of gains, the Bloomberg Barclays Global Aggregate Treasury Index hit a loss in 2021, with its duration remaining just below a record high. Given that level and the approximately $ 35 trillion bond pile that the index tracks, each percentage point increase in yield would mean about $ 3 trillion in losses.

What makes things worse, says Tannuzzo, is an aspect of bond mathematics embedded in many bonds that determines that, as yields increase, their duration also increases. This is mainly due to something called negative convexity – which also means that bond prices will fall at an ever-increasing rate as rates rise.

The duration of the estate is a little more difficult to understand. Some use dividend yields to calculate how many years it will take to get someone’s capital without any increase in dividends, with more time equal to a longer duration – generally speaking, a lower dividend rate means a longer duration.

Vulnerable

Growth actions, strongly represented by technology companies, are an example of this. The increase in earnings will bring a major blow to the discounted values ​​of its cash flows, many of which are expected in the future. And the weight of technology stocks in major stock indexes is greater than during the technology bubble of the late 1990s.