Cart (0)
business newsLong Bond Price Volatility Increasing
Why investors should start to lower their duration risk and shift out of longer-dated Treasuries even though they may have a price pop ahead.
PRINT
 |
|
One phenomena described by chaos is a “phase change;” think of this as a column of cigarette smoke rising in a straight column and then suddenly becoming turbulent. The long end of the Treasury market began a phase change during the financial crisis of 2008. Once Citigroup (C) was bailed out in November 2008 and Tim Geithner was nominated to be the new Secretary of the Treasury on the same day, marked with a green line on the chart below, the phase change acquired some measure of persistence. It's as if a desert suddenly became a rain forest and remained a rain forest to the befuddlement of the resident cacti.
What we see in the chart above is the course of 30-Year Treasury yields going back to 1980 and daily percentage changes in those yields lying outside of a 97.5% in-sample confidence interval. Those days, marked with red, have become a common occurrence, have they not?
Now let’s return to the behavioral aspects. We become accustomed to a given state of affairs -- remember the “Great Moderation” of the last decade? -- and presume it will last forever; we then acclimate ourselves to the next persistent state. This works in all aspects of investing; by the early 1980s, stocks were unloved and everyone thought they would remain unloved. Then they became loved until 2000, at which point few investors could believe what the next decade would look like. Now stocks are unloved again. Rinse and repeat; this is simply the way of the world.
But higher bond volatility has consequences. One of the odder consequences of fixed-income mathematics is the price volatility of long-term bonds will rise as yields fall as the dollar value of each basis point increases. A more volatile asset is a riskier asset, and a riskier asset has to get priced lower or bought in lower quantities to compensate. As corporate bonds are priced as a spread to Treasuries and as stocks have to compete with corporate bonds, the persistent and greater volatility in long-term Treasury yields has affected risk acceptance in equities. It can't work otherwise, and “can't” is a very strong term not used lightly in these parts.
This is why investors should start to lower their duration risk and shift out of longer-dated Treasuries even though these Treasuries may have a price pop ahead of us. The duration of a current 30-Year Treasury is 17.70 at present; this means the bond will lose 17.7% of its principal, more than 4.5 years of coupon income, if long-term rates rise 100 basis points. This is a statement and not a forecast as I don't expect an imminent rise in rates, but no one ever expects the grenade to land in their lap, do they? The time to manage risk is when there's no need to manage risk.
Follow the markets all day every day with a FREE 14 day trial to Buzz & Banter. Over 30 professional traders share their ideas in real-time. Learn more.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
