A $10 Trillion Market Has a Big Interest-Rate Shock Problem

“Location, location, location” is a phrase sometimes uttered when selecting investments in the real estate market.

For investors in the $10 trillion market for U.S. corporate bonds, the saying might well be “duration, duration, duration.”

As central banks around the world gear up to raise interest rates in the face of higher inflation, there’s a looming risk for credit. That’s because many companies have been selling bonds with longer terms and at lower spreads, resulting in investors taking on what’s known as duration risk, or higher sensitivity to interest rates. This means that when benchmark rates rise, investors in investment-grade corporate bonds are typically vulnerable to big drops in value.

For an asset class that’s supposed to be all about steady income over time, it’s a big deal. And duration risks are rising. Traders ramped up their expectations for rate hikes on Thursday after new inflation data showed consumer prices surged by 7.5% in January, the largest increase since 1982.

Duration risk in corporate credit is now the flip side of companies taking advantage of low interest rates in recent years to rebuild their balance sheets and issue debt at longer terms and cheaper borrowing costs.

Duration of the Bloomberg U.S. Corporate Bond Index has jumped to around 8.3 years while that of the Bloomberg U.S. Treasury Index has risen to 6.9 years, leaving the widest gap between the two asset classes since 2013.