5 Reasons Your Duration May Be Too Short

August 29, 2014

Fears of an impending bond market rout have been greatly exaggerated.

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Anthony Parish, vice president of Research & Portfolio Strategy at Austin, Texas-based Sage Advisory Services.

If you talk to a lot of fixed-income investors, as we do, you know that many have shortened their durations in recent years with expectations that interest rates should rise above near-record-low levels.

Here are five reasons that view may be out of sync with current market conditions:

1) It turns out, Federal Reserve tapering is a nonissue

Compared with last year, the U.S. deficit is shrinking by about $190 billion, which means the U.S. Department of the Treasury is issuing about $15.8 billion less debt per month to fill the gap.

Meanwhile, the Fed has been tapering its large-scale asset purchase program by $10 billion a month. The supply of on-the-run Treasurys available for investors this year has been going down as the Fed tapers, not up. All else equal, scarce supply keeps Treasury prices high and rates low.

2) U.S. economic conditions cannot sustain meaningfully higher rates

Although the economy has come a long way since the great recession, it still has a long way to go before rates shoot up. The chart below shows the gap between the current level of economic indicators—GDP growth, inflation, unemployment, housing starts and consumer confidence—versus their average levels at the beginning of the last four tightening cycles.

In each case, current economic indicators have large gaps versus their previous levels at the time the Fed began tightening. The Fed's policy changes are "data dependent," and the data improvement has been slow.

For a larger view, please click on the image above.




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