The cheapest dollars in years are spurring an increase in foreign investment in U.S. government bonds as pension funds increase their holdings – and this pickup in demand could weigh on Treasury rates even as the economy is strengthening.
The WSJ Dollar Index, which measures the greenback against a basket of currencies, is down 2.9% this quarter so far and hovering near the lowest level in about five months. The price of hedging the dollar through forward rates was also the cheapest for at least six years last week and remains close, according to Deutsche Bank analysis.
“If I were to buy a bond market, which is the case with a lot of investors, I would buy the US Treasury,” said Laurent Crosnier, investment director at the London branch of Amundi, the largest manager of active in Europe. The positive yield and low cost of hedging “make the US Treasury attractive relative to others.”
The benchmark 10-year government bond yield slipped below 1.5% earlier this week, closing at 1.458% on Thursday, the lowest level since March 2. Prices rise when yields fall.
Government bonds are popular in times of poor economic performance for safety and liquidity. The recovery from the pandemic is likely to lead fund managers to reduce their holdings as they position their portfolios for better times and less uncertainty. Investors widely expect inflation to rise as a result of a combination of pent-up demand, supply constraints and stimulus spending. This is also seen as negative for conventional bonds, whose fixed cash flows lose purchasing power when prices rise.
Despite this, recent Treasury bond auctions have seen an increase in demand from foreign investors. A 5-year debt sale on May 26 received the most bids from foreign investors since August at over 64%. A 7-year-old show in the same week has seen the most since January. The latest data from the US Treasury Department showed that major foreign investors increased their holdings of longer-dated US government bonds in March.
The depreciation of the dollar is linked to high levels of liquidity in the market resulting from a combination of Federal Reserve stimulus measures and colossal budget spending by the White House, analysts say.
Cash holdings have exploded during the Covid-19 lockdowns, with deposits in commercial banks in the United States reaching a record high of $ 17.1 trillion, according to the St. Louis Federal Reserve. Money market fund assets total $ 4.6 trillion, according to the Investment Company Institute, which is near record levels.
US money market yields have come under pressure from excess liquidity, with some being pushed towards zero.
Forward rates, which are used to lock in an exchange rate at a certain point in the future and reduce the risk of currency fluctuations, are valued based on money market rates and the difference between the yields on the debt. short-term domestic of the two currencies. markets. The smaller the spread, the cheaper the trade, and that is exactly what happened when US rates fell.
“If you take a 10-year US Treasury bill and hedge with a three-month look ahead, the return you get is around 0.9%,” said Althea Spinozzi, fixed income strategist at Saxo. Bank.
This is higher than all European government bonds of the same maturity. The yield on Italian 10-year bonds was 0.755% on Thursday. Japan’s equivalent bond returned 0.659%.
True, many analysts expect Treasury yields to rise as economic growth and inflation in the United States accelerates. The median of the 47 estimates projects the benchmark 10-year government bond yield to reach 1.90% by the end of the year, according to FactSet data.
“That means if you were to act on this trade now, that second sale could wipe out the carry returns you were hoping to get,” said Ralf Preusser, fixed income strategist at Bank of America..
“We believe the dollar rate sell-off will be slower and more gradual once we hit 2% for the 10 years. This is where we expect it to start, with flows of European investors. and Japanese, ”he said.
Another source of money flowing into Treasuries has been pension funds. Strong rallies in riskier assets, like stocks, over the past few months have helped close many funds’ gap between the value of their assets and their liabilities, allowing them to shift cash to safer assets, like obligations.
U.S. pension funds moved nearly $ 90 billion in funds from equities to fixed income in the first quarter of this year, of which $ 41 billion went to treasury bills, analysts at Bank of America.
These flows have helped keep yields low, but Mike Bell, global markets strategist at JP Morgan Asset Management, said he expects 10-year yields to hit around 2% over the next 12 months. – and that this level would attract even more investment flows. .
“The rise in yields from there will be much slower and Treasuries will be much more attractive,” he said.
—Paul J. Davies contributed to this article.
Write to Anna Hirtenstein at [email protected]
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