Rising geopolitical tensions and long-term bond crash trigger global capital 'safe haven exodus': scramble for short-term bond yields

Zhitong Finance APP has noted that investors are embracing shorter-term corporate bonds, aiming to lock in high yields while limiting their exposure to interest rate volatility and market turmoil.

This strategy has already paid off: over the past month, as longer-duration bonds have struggled, bonds maturing within five years have outperformed the broader Bloomberg Euro Investment Grade Corporate Bond Index, with a similar situation in the US market. Given that short-term bonds offer stable returns, chasing slightly higher yields further along the yield curve has proven hardly worthwhile.

Jim Caron, Chief Investment Officer of Morgan Stanley Investment Management, stated: “Currently, what’s putting pressure on returns is the duration factor.” He is investing in a portfolio of high-quality, short-duration bonds that “reduces some rate sensitivity without sacrificing yield.”

This month, the outbreak of conflict between the US and Iran heightened inflation concerns, in turn weighing on US Treasury prices and squeezing investment returns.

On Wednesday, the Federal Reserve paused rate hikes, and the market was once again thrown into turmoil; as investors bet this only delayed an inevitable hike, the price of 30-year US Treasuries slumped. The European Central Bank also left rates unchanged last week, but policymakers have signaled that further tightening could come as early as September.

By shifting to shorter-term credit bonds, investors can limit the impact from sharp changes in rate expectations. Longer-term debt is particularly sensitive to rising rates, since prices must drop more to compensate buyers for the lower coupons.

According to a report from Bank of America strategists citing EPFR data, funds focused on the short and medium term continued to attract new inflows last week even as the broader market saw outflows.

Short-term sales are more favorable

The prices of short-term bonds also tend to fluctuate less, as they are closer to maturity. As they approach maturity, their prices naturally converge to face value, which helps buffer portfolios against fluctuations in interest rates and credit spreads.

Over the past month, total returns for bonds maturing in less than a year were roughly flat, while the Bloomberg index fell 0.9%; by comparison, bonds with durations of 10 years or more dropped by over 2.9%.

Flat curve

Currently, investors lack much incentive to take on the extra risk of holding longer durations. For example, according to compiled data, the increase in yields from three-year to nine-year bonds is only 67 basis points.

Rufaro Chiriseri, Head of European Fixed Income at RBC Wealth Management, said: “Extending duration doesn’t provide much extra benefit, so you’re actually better off choosing shorter durations and still getting a decent return. We feel very comfortable taking a shorter-duration stance, and are even willing to accept slightly lower credit quality within investment grade.”

Some investors believe higher forward yields aren’t worth the risk

By reducing duration risk exposure, investors can improve their portfolio’s so-called Credit Breakeven, giving them more buffer as credit spreads widen or rates move. Currently, spreads are near their lowest levels since 2008, and asset managers believe there is little room for further narrowing.

For now, as the market continues to digest expectations of further central bank hikes, the extra risk of buying longer-term bonds will leave investors facing potential losses.

Mark Haefele, Chief Investment Officer at UBS Global Wealth Management, said: “While central banks may remain cautious in the short term, we expect inflation pressures to ease over the next 12 months, and recommend locking in today’s high yields, especially in quality, short- and medium-term duration bonds.”