One Word, And One Word Only: “Duration”

Duration.

That’s probably a term you should familiarize yourself with if you fancy yourself a fixed income investor.

See the thing is, when central banks pull the punchbowl away, you’re going to have some problems if you’re caught with your hand in the duration cookie jar (boom: we just pulled off the rare “punch bowl/cookie jar” metaphor combo).

In an effort to help you adjust your strategy to a changing rates environment, we present the following from BofAML who is out on Wednesday reflecting on “four key periods” that have characterized the post-crisis “duration cycle”.

Via BofAML

The duration cycle – a reflection of market sentiment

The reach for duration is directly linked to market sentiment. There have been four key periods in the recent history when macro drivers have instigated a shift on investors’ appetite for duration. We assess flow trends vs macro events over the past years.

  • Fed tapering tantrum (May 2013): investors were reaching for duration as the Fed was supporting the market with its third take on QE. However, when tapering risks emerged, investors flocked back to short-duration credit to protect against steeper rates curves and higher rate levels.
  • Pre ECB QE (Q3-Q4 2014): investors where adding duration as ECB cut the depo rate below zero.
  • Post ECB-QE (Q1 2015): Post the announcement of the ECB PSPP investors reached for yield by extending duration, while the subsequent Bund shock (May 2015) came to unwind this euphoria.

Duration

  • US elections, the global reflation trade and rising political risk (Nov’2016 – now): More recently we have seen a very strong bid for short-dated IG bonds. Investors are trying to cut duration risk as (i) rates have moved aggressively higher and more importantly (ii) curves have steepened in the past couple of months.
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