Before the sell-off began, the running yield in composite Treasury indices were around 0,5%, with duration about 7 years. Thus, with limited fixed rate cushion, a long position in such an index exhibited a very high probability for a negative return at any occasion when yields move higher. A long position in the same index today, however, has a totally different risk/reward profile, with a running yield at around 5%. As the chart serves to illustrate, a crude approximation of the total return over 12 months is +12% if the running yield drops by 1 ppt, with a total return at -2% if yields continue up by 1 ppt.
However, for the latter scenario to materialize, it would likely be necessary to pencil in a scenario in which Fed hikes another 1 ppt (to 6,50%) as the level of 10 year yields rarely surpasses the level of the policy rate at the peak of a hiking cycle.
