by Andreas Hohenadl, Euro on Sunday
If you look at the mere numbers, you can quickly become tempted. The US Federal Reserve’s resolute action in raising interest rates has made US government bonds attractive again. At least at first glance. In the meantime, the papers offer quite attractive yields. In the past six months, interest rates on ten-year American government bonds have doubled to currently just under three percent. In Germany, the ten-year yields just turned positive at the time and ranged at 1.2 percent.
Given the blatant interest rate differential, it’s a smart move for eurozone investors to jump into fixed income on the other side of the Atlantic, isn’t it? In principle yes, if it weren’t for the currency.
The strong dollar is the great spoilsport. The problem: “US government bonds are quoted in the national currency – and German investors cannot avoid a currency exchange if they ultimately want to use the capital in euros,” explains Carsten Roemheld, capital market strategist at Fidelity International.
The US dollar, the world’s dominant reserve currency, has appreciated significantly in recent months. Higher interest rates make investments in dollars comparatively more attractive. But if you come from a different currency area, there is a risk of exchange rate losses in the end. But isn’t there a way to protect yourself against it?
Here, too, the answer is: in principle yes. A hedging of the currency pair euro/US dollar, the so-called hedging, is quite possible. But this approach does not currently make sense. “Currently, hedging is so expensive that any hope of higher interest income is dwindling,” says Roemheld.
Because a so-called cross-currency swap, in which two trading partners exchange nominal amounts including interest in two different currencies via a futures transaction, currently costs investors 2.7 percent annually. The yield on a ten-year US government bond is currently around 2.95 percent.
It is obvious that there is not much left after the exchange rate hedging. Roemheld’s conclusion: “The sharply increased costs for currency hedging prove: The currency market is just textbookly compensating for the interest rate differential.”
Not an opponent, but a friend
So do eurozone investors have to stand on the sidelines? no Your motto should only be: If you can’t defeat an opponent, join forces with him. It is therefore about profiting from a strengthening dollar and a weak euro. And that works quite well not only for equities, but also for interest rate investments, as the past few months have shown.
A crucial factor is the maturity of the bonds. The shorter this is, the less the prices of the paper react to changes in interest rates. Corresponding bonds therefore offer investors the opportunity to be able to absorb almost the pure dollar movement against the euro.
The fund professionals at Gané, for example, use this opportunity: “In the bond segment, we benefit from the strong US currency through our US dollar exposure,” reports market strategist Marcus Hüttinger. “The greenback is currently living up to its reputation as a safe haven in times of crisis. Due to the geopolitical tensions, we deliberately increased our weighting in short-dated US government bonds at the turn of the year.”
According to Hüttinger, the weakness of the euro reflects the tense political and economic situation in Europe at the moment. And the likelihood of a recession will increase as the energy crisis persists. Since the ECB is closely monitoring inflation and the depreciation of the domestic currency, one must be prepared for short-term rate hikes. “That’s why we are also focusing on very short maturities for fixed-interest bonds in Europe.”
Short runners with currency pep
With the listed index fund SPDR Bloomberg 1-3 Months T-Bill ETF, investors rely on US government bonds with an investment grade rating and a remaining term of one to three months. Viewed in US dollars, the ETF has gained 0.1 percent since the beginning of the year. However, euro investors can look forward to a gain of around twelve percent in the index fund. However, if you want to secure high interest rates over a longer period of time, look at long-dated dollar bonds, such as those from Mexico. Although these papers can fall if interest rates continue to rise, investors with an ETF on US short-term bonds have also achieved a 13 percent plus since the beginning of the year. Advertise when interest rates fall. Those who hold them until the end of the term collect the current return of six percent year after year.
But can the trend of the dollar strength or euro weakness continue? Very likely as long as capital continues to flow into the dollar area in search of a safe haven or looking to benefit from stronger economic growth. The trend could only be reversed if US inflation falls noticeably and the central bank loosens the reins on monetary policy again. Bethany Payne, portfolio manager at Janus Henderson, says with regard to the euro: “Longer term, we expect growth concerns to prevail and the US dollar to remain strong into 2023. Sentiment in Europe is poor, especially as the energy crisis threatens to escalate in winter. ”
Investor info
With the so-called Treasury Bills, or T-Bills for short, the American government secures its short-term borrowing. The term of the money market paper ranges from a few days to a maximum of 52 weeks. With the SPDR Bloomberg 1-3 Month T-Bill ETF, investors invest in US Treasury bills with a remaining term of one to three months. Advantage: Interest rate changes hardly affect the prices of these papers, so investors are relaxed about a further appreciation of the dollar.
BOND
Six percent by 2040
Mexico has a long-dated government bond denominated in US dollars (USD). The bond runs until 2040 and offers an interest coupon of 6.05 percent, which at the current rate around the nominal value also corresponds to the annual return. Mexico is considered to be a very solid debtor and is classified by the rating agencies in the top investment grade range (S & P: BBB, Moody’s: Baa2, Fitch: BBB-). The denomination is USD 2,000 and the volume is USD 4.25 billion.
BOND FUNDS Fully invested in the dollar
The Merian Global Dynamic Bond Fund, which belongs to the British fund provider Jupiter, is not only convincing at the moment, but also over the long term with its performance. The fact that things are going so well this year is also due to the fact that around 105 percent (!) of the fund is invested in US dollars. On the other hand, the portfolio managers hold a short position of around 6.5 percent on the euro. Three quarters of the fund currently consists of government bonds, and it holds almost nine percent in first-class corporate bonds.
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