First they came for the yield, then they came for the duration.
A Goldman Sachs Group Inc analysis says investors could be mired in a world of pain if yields on long-dated assets snap higher. Just a modest backup in rates could inflict outsized losses on bond portfolios — a sobering prospect in light of the recent jump in longer-dated bond yields that's already eating into bondholders' capital returns.
A 1 percent increase in interest rates could inflict a $1.1 trillion loss to the Bloomberg Barclays U.S. Aggregate Index, analysts at Goldman calculate, representing a larger loss for bondholders than at any other point in history. With the bank predicting the selloff in bonds has further to run, that remains "far from a tail scenario," its analysts write.
Bets on longer-maturity obligations had paid off handsomely for most of the year amid a global bond rally triggered by expectations that weak economic activity will persuade central banks in advanced economies to postpone tightening monetary policy. Asset purchases by the Bank of Japan, Bank of England and the European Central Bank helped the average maturity of new U.S. corporate bonds climb to a peak of 11.3 years in August. With average bond maturities worldwide now more than double the inflation-adjusted level of 2009, and three times that of 1994, Goldman says there's an elevated risk of losses if rates spike higher.
"We see potential for the rates market to continue to sell off, and the notional amount of duration dollars at risk is unprecedentedly large," Goldman fixed-income analysts, led by Marty Young, wrote in the report on Monday.
The effective average duration of the global bond market, as measured by the Bloomberg Barclays Global Aggregate Index, has risen to 6.98 years, as of mid-October, compared with 6.60 years in January. Goldman's $1 trillion estimate reflects potential losses on dollar-denominated investment-grade cash bonds, and therefore may form a conservative estimate of the risks facing money markets. It excludes a whole gamut of duration risks facing the U.S. interest-rate swap market; from junk obligations, to the trillion-dollar pile of fixed-rate mortgages, and corporate loans held on bank balance sheets.
