Europe's Foreign Debt Binge Could Push U.S Rates Lower
September 22 2017 - 05:59AM
Dow Jones News
By Mike Bird
European investors are buying more foreign bonds than ever
before, another sign that many fund managers aren't expecting
tapering from the European Central Bank to boost local yields
anytime soon.
The trend has global implications. Heavy demand from the
eurozone puts pressure on yields elsewhere in the world, including
the U.S., and lowers borrowing costs there. The eurozone's
investors are big spenders: In 2016, local investors bought around
$500 billion in foreign, mainly government, bonds, almost enough to
cover the entire $584.7 billion U.S. budget deficit.
The most recent numbers, between May and July, show that the
eurozone's investors bought EUR160.8 billion ($191.7 billion) in
international bonds, the largest sum in any three-month period on
record, according to data from the ECB.
ECB stimulus, including negative interest rates and a massive
bond-buying program, have pushed down the yields on local
government debt to record lows. That has made investors look
elsewhere for returns.
Now, robust growth in the eurozone is raising expectations that
the ECB will roll back its monetary policy, easing more quickly
than once expected. As ECB buying subsides, that should push yields
higher.
But eurozone investors don't appear to be buying into the idea
that local yields are about to get more attractive.
In June, ECB President Mario Draghi said that "all the signs now
point to a strengthening and broadening recovery in the euro area,"
in a statement that investors interpreted as being the central bank
laying the ground for tapering. But that didn't stop eurozone
investors from snapping up EUR40.9 billion in foreign bonds in the
following month alone.
"The rhetoric is about higher rates and tapering...but the
reality is that government bond yields and interest rates in Europe
are extremely low and even negative in some places," said Mouhammed
Choukeir, chief investment officer at Kleinwort Hambros.
"So you're going to see that continued search for yield
overseas."
European government bond yields haven't shifted significantly
against their global peers since the ECB began changing its tone on
tapering.
That is particularly so in the short-dated government bond
market.
German two-year bund yields are now 2.1 percentage points below
U.S. two-year Treasury yields, a gap that has widened from 2
percentage points six months ago.
That is partly because the Federal Reserve has already moved on
tightening its own monetary policy. On Wednesday, Fed officials
kept the door open for a December interest-rate rise at the
conclusion of their September meeting. Officials also said that
they would begin shrinking the Fed's portfolio of bonds in
October.
"There is a good chance the ECB hasn't done any hikes by the end
of 2018," said Mike Bell global market strategist at J.P. Morgan
Asset Management. "Whilst that gap between very low bond yields in
the eurozone and somewhat higher global yields persists, you could
well see continued large foreign bond purchases," he added.
All that could mean lower borrowing costs for Americans.
In 2012, the Fed published a research paper estimating that a
$100 billion increase in foreign official demand -- from
institutions like central banks and sovereign-wealth funds --
reduces the five-year Treasury yield by 0.4 to 0.6 percentage point
in the short-run.
Adding to the attraction of investing abroad for European
investors: The cost of hedging their exposure to movements in
foreign currencies has fallen this year.
A five-year cross-currency basis swap currently costs a European
investor around 0.35 percentage point above interest rates --
allowing them to borrow in dollars and hedge their risk -- down
from a peak of 0.56 percentage point last year.
Still, despite European investors buying their bonds abroad, the
eurozone is now registering inflows in the equity market, a trend
that some analysts don't see reversing soon. Earnings have picked
up in Europe, and compared with U.S. stocks, equities in the region
are relatively cheap
"Looking at the growth momentum and the economic reform story,
we expect that to continue," said Jordan Rochester, strategist at
Nomura.
Write to Mike Bird at Mike.Bird@wsj.com
(END) Dow Jones Newswires
September 22, 2017 05:44 ET (09:44 GMT)
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