Duration risk hits US bond portfolios amid Brexit

The Office for Financial Research in US says bond investors are at risk of heavy losses following Brexit, as interest rate risk remains high.

Duration risk for US bond portfolios is near the top of its long-term range, leaving investors open to heavy losses from jumps in interest rates following Brexit. 

The Office of Financial Research’s (OFR) latest financial stability report detailed the risks Brexit could have on US markets.

It explained low interest rates have prompted investors to take risks to get better returns.

“Long-term US interest rates have declined to ultra-low levels, which can motivate excessive risk-taking and borrowing,” the OFR said.

Duration in US bond portfolios is now near the top of its long-term range, as the OFR warns investors are “open to heavy losses” from a jump in interest rates or other shocks like Brexit.

The financial stability report also said liquidity in major US bond markets is “structural and slow to change”, which will be “destabilising during a time of severe stress.”

Overall risks to US financial stability remained in the medium range, but have been “pushed higher” following the shock EU referendum result.

OFR said: “[Brexit] introduces months or years of uncertainty about the rules governing the UK’s investment, financing, and trade relations.”

It concluded: “Because the UK economy and especially the UK financial system are highly connected with the rest of Europe and the US, severe adverse outcomes in the UK could pose a risk to US financial stability.”