The rising cost of hedging US Treasuries in the foreign exchange market is eroding the attractiveness of the bonds for international investors, as it negates the extra yield US bonds pay over comparable European and Japanese debt, Deutsche Bank said in a report.
US government bonds offer far higher yields than comparable debt in Japan and Europe, where yields on many bonds return nothing, or have turned negative, meaning that investors pay for the perceived safety of holding the bonds. Benchmark US 10-year notes, for example, yield 1.54 percent, while comparable German bond yields are negative 0.08 percent and Japanese 10-year notes yield negative 0.02 percent. Higher US yields have attracted international investors seeking higher returns, with the US Federal Reserve expected to raise rates again this year as Japanese and European central banks remain highly accommodative.
Recently, however, the yield pick-up has disappeared, as the cost of hedging the foreign exchange risk of the bonds using short-dated forwards has increased, Deutsche Bank strategist George Saravelos said in the report, sent on Monday. "There now isn't any global fixed income investor that can make decent money by buying hedged US Treasuries," he said.
A year ago Japanese investors could earn almost 1 percent in extra yield by buying currency-hedged Treasuries, compared with local bonds. However, now that difference has tumbled to almost nothing, Deutsche Bank noted. Euro-based investors similarly could have generated an approximately 0.60 percent in extra yield from Treasuries a year ago, and now would earn less than local bonds, the bank said. Foreign investors seeking US government debt will now need to buy the bonds unhedged for the trade to be profitable, or turn to higher-risk bonds such as corporate debt to generate income, Saravelos said.