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Cheap dollars attract foreign investors in government securities

The cheapest dollars have been boosting foreign investment in US government bonds for years as pension funds increase their stakes – and that rising demand can weigh on interest rates, even as the economy strengthens.

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

“If I had to buy a bond market, as is the case with many investors, I would buy the US Treasury Department,” said Laurent Crossier, chief investment officer at Amundi̵

7;s London branch, Europe’s largest asset manager. Positive returns and low hedging costs “make the US Treasury Department more attractive to others.”

10-year government bond yields fell below 1.5% earlier this week, closing at 1.458% on Thursday, the lowest level since March 2. Prices rise when profitability falls.

Government bonds are popular in times of poorer economic safety and liquidity performance. Recovery from the pandemic is widely expected to lead to a reduction in fund holders as they position their portfolios for better times and less uncertainty. Investors expect rising inflation from a combination of stagnant 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.

However, recent government bond auctions have seen increased demand from foreign investors. The 5-year debt sale on May 26 received the most offers from foreign investors since August at over 64%. The 7-year edition in the same week is observed the most since January. The latest data from the US Treasury Department showed that large foreign investors increased their holdings of government bonds with a longer maturity in March.

The devaluation of the dollar is due to high levels of liquidity in the market due to a combination of a stimulus from the Federal Reserve and colossal fiscal spending from the White House, analysts say.

Cash increased during the blockade of Covid-19, with deposits in U.S. commercial banks at a record $ 17.1 trillion, according to the St. Louis Federal Reserve. Money market fund assets amount to $ 4.6 trillion, according to the Investment Companies Institute, which is close to record levels.

US money market yields are under pressure from excess liquidity, with some being pushed to zero.

Forward rates, which are used to fix the exchange rate at some point in the future and reduce the risk of currency fluctuations, are determined based on money market interest rates and the difference between the yield on domestic short-term debt of the two currency markets. The smaller the difference, the cheaper the trade – and this is exactly what happened when US interest rates fell.

“If you take a 10-year US treasury and hedge with quarterly progress, the return you get is about 0.9%,” said Altea Spinozzi, a fixed-income strategist at Saxo Bank.

This is higher than all European government bonds with the same maturity. The yield on 10-year Italian bonds was 0.755% on Thursday. The Japanese equivalent bond yielded 0.659%.

Yields on 10-year government bonds fell earlier this week to their lowest level since March 2nd.


Ting Shen for The Wall Street Journal

Of course, many analysts expect the Treasury’s profitability to weaken as US economic growth and inflation rise. The median of 47 forecasts predicts that the reference yield on 10-year government bonds will reach 1.90% by the end of the year, according to data from FactSet.

“This means that if you had to act on this deal now, this second sale could ruin the return you hoped to make,” said Ralph Preuser, a fixed-income strategist at Bank of America..

“We believe that the sale in dollar exchange rates will be slower and gradual once we reach 2% for the 10-year. “This is where we expect it to start, with flows of European and Japanese investors,” he said.

Another source of money coming into the treasuries is pension funds. Strong rallies in riskier assets, such as stocks, in recent months have helped fill the gap that many funds have between the value of their assets and liabilities, allowing them to transfer money to safer assets, such as bonds.

In the first quarter of this year, U.S. pension funds transferred nearly $ 90 billion from the funds and turned them into fixed income, with 41 billion of them going into government securities, according to analysts at Bank of America.

These flows have helped hold back profitability, but Mike Bell, a global market strategist at JP Morgan Asset Management, said he expects 10-year yields to rise to about 2% over the next 12 months – and that level will attract even more investment. flows.

“Increasing yields from there will be much slower, and government securities will be much more attractive,” he said.

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

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