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The cheapest dollars in years are spurring increased foreign investment in US government bonds at the same time that pension funds are consolidating their holdings – and this surge in demand can affect Treasury prices even as the economy strengthens.
The WSJ dollar index, which measures the greenback against a basket of currencies, is down 2.9% this quarter so far, and is hovering near its lowest level in nearly five months. Hedging dollars through forward rates was the cheapest in at least six years last week and is still close, according to an analysis from Deutsche Bank.
“If I were to buy a bond market, which is the case for a lot of investors, I would buy the US Treasury,” said Laurent Crosnier, chief investment officer at Amundi in London, Europe’s largest asset manager. The positive yield and low hedge cost “make the US Treasury attractive to others”.
The benchmark 10-year government bond yield fell below 1.5% earlier this week, to close at 1.458% on Thursday – the lowest level since March 2. Prices rise when returns fall.
Government bonds are popular in times of poor economic performance for safety and liquidity. It is widely expected that the recovery from the pandemic will lead to fund managers cutting their holdings as they position their portfolios in better times and less uncertainty. Investors widely expect increased inflation from a combination of pent-up demand, supply constraints, and stimulus spending. This is also seen as negative for traditional bonds, whose constant cash flows lose purchasing power when prices rise.
Despite this, recent Treasury auctions have seen a slight rise in demand from foreign investors. The 5-year debt sale on May 26 received the largest number of bids from foreign investors since August at more than 64%. The 7-year issuance in the same week was the largest since January. The latest data from the US Treasury showed that major foreign investors raised their holdings of long-term US government bonds in March.
Analysts said the dollar’s depreciation is linked to high levels of market liquidity from a combination of Federal Reserve stimulus and massive fiscal spending from the White House.
Cash holdings swelled during the Covid-19 lockdowns, with deposits in US commercial banks reaching $17.1 trillion, according to the St. Louis Federal Reserve. Total assets in money market funds are $4.6 trillion, according to the Investment Company Institute, which is close to record levels.
US money market yields have come under pressure from excess liquidity, with some pushing towards zero.
Forward rates, which are used to stabilize the exchange rate at a certain point in the future and reduce the risk of currency fluctuations, are quoted based on money market rates and the difference between the returns in the short-term domestic debt of the two currencies. markets. The smaller the gap, the cheaper the trade – and that’s exactly what happened with lower US interest rates.
“If you take 10-year US Treasuries and hedge three-month forwards, the yield you get will be about 0.9%,” said Althea Spinozzi, a fixed income analyst at Saxo Bank.
This is higher than all European government bonds with the same maturity. The Italian 10-year bond yield was 0.755% on Thursday. The equivalent Japanese bond yield is 0.659%.
The benchmark 10-year government bond yield fell earlier this week to its lowest level since March 2. Photo: Ting Shen for The Wall Street Journal
To be sure, many analysts expect Treasury yields to rise as US economic growth and inflation pick up. An average of 47 estimates expects the benchmark 10-year government bond yield to reach 1.90% by the end of the year, according to data from FactSet.
“This means that if you were to take this trade now, the second sale could eliminate the carryover returns you were hoping to generate,” said Ralf Preusser, fixed income analyst at Bank of America.
We think the dollar sell-off will be slower and more gradual once we hit 2% for 10 years. This is where we expect this to start, with inflows from European and Japanese investors.
Another source of money flowing into Treasurys is retirement funds. Strong rises in riskier assets, such as stocks, in recent months have helped close the shortage many funds have between the value of their assets and liabilities, allowing them to shift liquidity to safer assets, such as bonds.
US pension funds transferred nearly $90 billion of money from stocks to fixed income during the first quarter of this year, of which $41 billion went to Treasurys, according to analysts at Bank of America.
Those inflows have helped drive returns, but Mike Bell, global markets analyst at JP Morgan Asset Management, said he expects 10-year returns to rise to about 2% over the next 12 months — a level that should attract more investment flows. .
“The rise in yields from there will be much slower and Treasurys will be more attractive,” he said.
— Paul J. Davies contributed to this article.
Write to Anna Hirtenstein at [email protected]
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