Key points
- Given the highly uncertain investment environment, we believe that interest rate risk will continue to be a source of investment volatility that needs to be actively managed.
- Empirical duration can be a better practical measure of interest rate risk, in our view, as analytical duration tends to oversimplify price sensitivity and ignores real‑life variables.
- Active interest rate management should go beyond managing duration as risks and alpha opportunities can also be found in country selection, convexity, curve positioning, and security selection.
Managing interest rate risk continues to remain of critical importance as volatility looks set to persist amid a highly uncertain backdrop of sticky inflation, slowing growth, tighter central bank policy, and banking sector worries.
For several years, many fixed income managers have assumed that better information ratios could be achieved through active credit decisions rather than managing interest rate risk. Up until last year, that approach generally worked as very supportive central banks dominated the post financial crisis era and kept rate volatility muted. But with central banks retreating, the environment has changed, meaning those days of artificially low interest rate volatility are likely behind us now.
Interest rate volatility rose significantly in 2022, fuelled by inflation surprises and central banks unleashing their most aggressive hiking cycles for more than two decades. While there was some hope that interest rate volatility could ease slightly this year, banking sector concerns have added a new uncertainty to an already challenging set of issues facing markets. Against this highly uncertain backdrop, we believe that interest rate risk will continue to be a source of investment volatility that needs to be actively managed going forward, particularly in the absence of central bank support, there is no buyer of last resort to help keep interest rate volatility suppressed.
This post was funded by T. Rowe Price
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