“We remain bearish global duration,” that’s the view of Bank of America’s rates analysts Ralf Preusser and Shyam S.Rajan, who in this week’s issue of the bank’s Global Rates Weekly research report, explain why they’re selling long duration bonds.
The average maturity of outstanding bonds has lengthened in recent years — with the likes of Austria and Argentina joining the 100-year club — as investors have sought out yield at any cost. When bond yields rise, the price of longer-dated debt falls faster than those of shorter-term maturities and investors exposed to this duration risk have been hit with a sudden shock over the past six months.
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The global duration sell-off
As economic indicators have improved in developed economies, central banks have turned hawkish. Preusser and Rajan point out that Canada, Europe and the UK, all of which have seen substantially weaker FX over the last 18 months, have "generally exceeded expectations in terms of data" and now " central bank expectations are turning quickly -- CAD 5y yields are up +90bp in three months, and UK 5y yields up +25bp this week alone on revised outlooks for the BoC and BoE."
Against such a backdrop the duo sees "little value in owning duration." Markets are now pricing in a 50% chance of a Bank of England Hike in November; a 40% chance of a Federal Reserve hike in December and one more hike from the Bank of Canada before the end of the year.
The long-awaited sell-off in global duration is finally starting to materialize and the next leg of the sell-off "rests on the ability of Congress to speed up the tax reform process."
"We continue to have a bearish view on rates on our belief that the expected value of tax reform hasn’t declined as much, even though its probability has undoubtedly gone markedly lower since the beginning of the year. In our view, as the decline in probability has been offset to some extent, by the 1) The proposed capital and liquidity easing measures (LCR and SLR) by the Treasury, if successfully passed, would mean a banking system that can more easily pass on a fiscal impulse to the real economy. 2) The probability of a bipartisan deal (however small) raises the risk that the tax reform bill would have few offsets in terms of revenue raisers leaving substantially higher deficits and higher UST supply and thereby a greater impact on yields."