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Cheap dollars attract foreign investors to treasuries

The cheapest dollars this year are encouraging an increase in foreign investment in US government bonds, while pension funds are increasing their holdings – and demand can be eased even if the economy strengthens.

The WSJ dollar index, which measures greenback against a basket of currencies, has fallen by 2.9% this quarter so far, hovering close to its lowest level in about five months. The price of hedging dollars through forward rates was also the cheapest for at least six years last week and is close, according to analysis from Deutsche Bank.

“If I bought a bond market, which is the case for many investors, I would buy the US Treasury,” said Laurent Crosnier, chief investment officer at Amundi’s London branch, Europe̵

7;s largest asset manager. The positive returns and low hedging costs “make the US Treasury attractive to others.”

Benchmark 10-year government bond yields fell below 1.5% earlier in the week and closed at 1.458% on Thursday – the lowest level since March 2. Prices rise when interest rates fall.

Government bonds are popular in times of poorer financial performance for security and liquidity. The recovery from the pandemic is widely expected to result in fund managers reducing their holdings as they place their portfolios for better times and less uncertainty. Investors broadly expect an increase in inflation from a combination of accumulated demand, supply constraints and stimulus expenditures. This is also seen as negative for conventional bonds, whose fixed cash flows lose purchasing power as prices rise.

Despite this, recent government bond auctions have seen an increase in demand from foreign investors. A 5-year debt sale on May 26 received the most bids from overseas investors since August of over 64%. A 7-year issue in the same week experienced the most since January. The latest data from the US Treasury Department showed that large foreign investors increased their holdings of longer-term US government bonds in March.

The depreciation of the dollar is linked to the high liquidity levels in the market from a combination of Federal Reserve stimulus and colossal fiscal spending by the White House, analysts said.

Cash has ballooned during Covid-19 lockdowns, with deposits in U.S. commercial banks sitting at a record high of $ 17.1 trillion, according to the Federal Reserve of St. Louis. Louis. Assets in money market funds total $ 4.6 trillion, according to Investment Company Institute, which is close to record levels.

US money market interest rates are under pressure from excess liquidity, with some being pushed towards zero.

Forward rates used to lock in an exchange rate at a particular point in the future and reduce the risk of currency fluctuations are priced based on money market rates and the difference between returns in the two currencies’ domestic short-term debt markets. The smaller the gap, the cheaper the trade – and that is exactly what has happened since US rates fell.

“If you take a 10-year U.S. Treasury and you hedge with a three-month forward rate, the return you get is about 0.9%,” said Althea Spinozzi, a fixed income strategist at Saxo Bank.

It is higher than all European government bonds with the same maturity. Italy’s 10-year bond yield was 0.755% on Thursday. Japan’s similar bond yielded 0.659%.

Benchmark 10-year government bond yields fell earlier this week to the lowest level since March 2nd.


Ting Shen for The Wall Street Journal

To be sure, many analysts expect government interest rates to cross as US economic growth and inflation rise. The median of 47 estimates that the 10-year government bond yield will reach 1.90% by the end of the year, according to data from FactSet.

“This means that if you were to trade this trade now, the second settlement could wipe out the returns you were hoping to make,” said Ralf Preusser, a Bank of America fixed income strategist..

“We believe that sales in dollar exchange rates will be slower and more gradual once we have reached 2% in the 10-year period. This is where we expect this to start kicking in with flows from European and Japanese investors, ”he said.

Another source of money flowing into the Treasury has been pension funds. Strong accumulations in more risky assets, such as equities, have helped in recent months close the deficit that many funds have between the value of their assets and their liabilities, allowing them to move cash to safer assets, such as bonds.

US pension funds switched nearly 90 billion. Dollars of funds out of shares and for fixed income in the first quarter of this year, of which 41 billion. Dollars went to the Treasury, according to Bank of America analysts.

These flows have helped keep interest rates down, but Mike Bell, global market strategist at JP Morgan Asset Management, said he expects 10-year interest rates to rise to approx. 2% over the next 12 months – and this level will attract even more investment flows. .

“The rise in interest rates from there will be much slower and the Treasury will be much more attractive,” he said.

Write to Anna Hirtenstein at anna.hirtenstein@wsj.com

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