Fixed-income investors are living in challenging times. This is especially true for investors in markets where supposedly safe government bonds are trading at negative yields – just like in Europe. German government bonds, which are considered to offer the highest credit quality, are yielding negatively across the whole maturity spectrum.
Investors who aim to achieve positive yields would have to be willing to take risks. One possible option may be to take on additional credit risk, as it comes with corporate bonds to varying degrees. Another alternative may be bonds denominated in foreign currency, which in some cases offer higher yields. Of course, the risk of a currency devaluation remains, which might quickly erode the yield pickup, or even result in a loss from a domestic-currency perspective.
At present, however, there is one further alternative for euro-based investors to consider. Due to higher spreads between U.S. money-market rates and the yields on long-dated U.S. dollar securities, it is currently possible to purchase a U.S. government bond of highest credit quality and hedge the currency risk, while still achieving a positive yield. However, this opportunity does not always exist, as our "Chart of the Week" demonstrates.
There are several reasons why such a strategy is working again: Monday's news regarding a promising Covid-19-vaccine development has prompted many traders to line up some trades on higher U.S. Treasury bond yields. Along with last Friday's powerful U.S. jobs report noting a decline of the unemployment rate to 6.9% and an election outcome seemingly welcomed by investors, markets have pushed U.S. government bond yields higher, reaching a level of 0.97% – a value that we have not seen since the outbreak of the pandemic back in March. Yields on German Bunds went up, too, but not as strongly as their U.S. peers'.
Another reason is central-bank policy: Truth be told, we deem it unlikely that the U.S. Federal Reserve (Fed), let alone the European Central Bank (ECB), will raise interest rates over the next years despite this positive short-term news. Chairman Jerome Powell has set the bar high for an interest-rate move by the U.S. central bank. And after the latest ECB Governing Council meeting, Christine Lagarde raised expectations that the ECB will rather expand its current monetary-policy package in December. Hence, as base rates are likely to be kept at current levels, hedging costs should not change much. Given the current increase in Treasury yields, it appears likely that investors may be able to log in the spread between German Bunds and euro-hedged U.S. Treasury yields for quite a while.
Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 11/9/20
DWS Investment GmbH as of 11/10/20
CRC 079577 (11/2020)