Searching outside the US for yield

Dec 30th, 2020 | By | Category: Fixed Income

By Robin Marshall, Director of Fixed Income Research, FTSE Russell.

Searching outside the US for yield

Searching outside the US for yield

According to recent data, US Treasuries have become expensive compared to other major sovereign bond markets over the last four years, as measured by US yield spreads versus the FTSE World Government Bond Index ex-US.

US yield spreads in 7 to 10 years have fallen from a peak of about 209 basis points in mid-2018 over the WGBI ex. US index to current levels of 79 basis points.

Chart 1: US Treasury 7-10 year yield spreads versus WGBI-ex. US and selected major government bond markets.

Source: FTSE Russell.

Source: FTSE Russell.

During times of economic turbulence and weak growth, US Treasury yields tend to fall faster compared with treasuries in other developed markets. Even with vaccines in the earliest days of availability, the US could face a resurgence of COVID-19 and another potential lockdown. Investors might be weighing US versus non-US government bonds and looking for opportunities in the broader international treasury market.

To illustrate, US Treasury yields fell more sharply than other major market debt obligations such as Japanese government bonds and German Bunds, between Q4 of 2018 and Q1 of 2020. During this period, the United States Federal Reserve cut policy interest rates by almost 300 basis points to near zero while policy rates in Japan and Germany were already below zero, so yields fell much less.

Chart 2: Performance of 7-10 year WGBI-ex. US index versus US Treasuries 7-10 years.

Source: FTSE Russell.

Source: FTSE Russell.

In recent years we’ve seen a cyclical pattern, whereby US Treasury yields have risen faster during periods of economic expansion, relative to other major markets, as in 2017 and 2018, and fallen faster during periods of slower growth and inflation, like 2019 and 2020. What this tells us is that US Treasuries outperformed during periods of falling yields and tended to underperform during periods of rising yields. If President-elect Biden is able to gain Congressional support for a substantial fiscal reflation package in 2021 in response to the economic impact of the pandemic, this cyclical pattern may be repeated, with US yields rising further than those in other markets, where deflationary pressures are still severe.

Karen Schenone, Head of iShares Fixed Income Strategy for BlackRock’s US Wealth Advisory Business, said, “Investors have the option to diversify across global fixed income markets through ETFs that track the FTSE World Government Bond Index. ETFs provide investors easy and efficient ways to access bonds from international markets.”

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)

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