Our perspective on global micro event and strategies.
Pat is a portfolio manager specializing in short-duration investing with a particular focus on non-USD markets for both internal and external clients who can access a global opportunity set. In addition, he supports USD-only portfolios as part of the Short Duration Team.
With the US Federal Reserve’s (Fed’s) interest-rate-hiking cycle now underway, it’s an important time to keep a close eye on non-US buyers of US dollar (USD) fixed income securities. Historically, Japanese and European investors have been large participants in the space. But if the Fed continues to raise US rates as expected, the positive carry return1 that these investors have recently reaped from US Treasuries may turn negative because the Fed’s rate hikes will increase the cost of foreign-exchange hedging for non-US investors, particularly in Japan. Indeed, taking account of currency hedging, European fixed income could start to look more attractive than its US counterpart to Japanese buyers.
Figure 1 shows the spread of hedged 10-year US Treasuries versus 10-year Japanese government bonds (JGBs) in light blue and the spread of hedged 10-year German bunds versus 10-year JGBs in dark blue. Both lines use a 12-month currency forward, instead of the more commonly used three-month forward, to better incorporate the…