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Are Low Global Yields Actually a Currency Play?

Posted by Jonathan Ting on September 12, 2019

Imagine a world where your mortgage lender is offering to pay you $3,500/year to take on a no interest $500,000 mortgage.

I would honestly consider retiring 30 years early, and attempt to take on 100 mortgages. You actually don’t have to imagine that hard because that’s the kind of the world we live in today.

Global Yields Reflecting a Bet Against the US Dollar

Currently the German 10Y Bund is yielding -0.7%. This means investors are willing to pay the German government €3,500/year to safe hold €500,000 for 10 years. I know, I’m thinking the same thing… aren’t bonds supposed to pay out interest? Unfortunately not in today’s world, and investors continue to pile into these negative yielding bonds. There are currently $15 trillion of negative yielding bonds trading in the markets today, and interest rates across Europe and Japan continue to go negative. This global flight to safety is unprecedented.

PhD economists at all of the largest banks are trying to make sense of all this. After all, the building block of modern day Finance states that there is a cost to capital and that interest should be paid from borrower to lender, not the other way around.

The best we can do is speculate as to the driving forces behind this conundrum – quantitative easing, recession fears, trade war escalation, hard Brexit, technology-driven deflation, etc. To be honest, no one really knows what this means moving forward, but the currency market might have an idea.

Global Yields and Currencies

If you are deciding whether to hold your savings account in US dollars (USD) or Chinese yuan (CNY), and you assume that the exchange rate of 1:7 will remain constant over the next 10 years, then it wouldn’t matter which currency you held as long as both interest rates were exactly the same. This is because the currency you chose to hold would grow at exactly the same pace as the other currency, and 10 years later they would still exchange at the same 1:7 rate. If rates stay the same, then the market is telling you that there is no difference in the currencies.

Let’s say instead that the interest rates were widely different (1% in the US and 3% in China). After 10 years, a 1USD bond would return 1.1USD and a 7CNY bond would return 9.1CNY. Thus, the future exchange rate would be 1.1:9:1 or 1:8.3, not 1:7. The spread in the bond yields essentially reflect future expectations of currency exchange rates.

Recently, we’ve seen an unprecedented spread in the bond yields of different countries.

Global Yields Continue to Decline with Europe Going Negative


Widest Global Spreads in Over 30 Years

Percentage Yield Spread

What is the market telling us today? If you purchase a 1000USD 10Y US bond today, you will receive roughly 1150USD 10 years later. If you purchase a 910EUR 10Yr German bund today (the equivalent of 1000USD given current exchange rate of 1USD=0.91EUR), you will receive roughly 850EUR 10 years later.

Indeed, investors lose money holding the negative yielding German bund, but how does that look on a USD-relative basis? Current rates are telling us that in 10 years the future exchange rate will be at 1USD:0.74EUR, versus then current exchange rate of 1USD:0.91EUR. This implies a -19% depreciation of the US dollar, and the wider the spread the larger the implied depreciation.

The market is telling us that investors are okay losing money holding European bonds, because the expected depreciation of the USD will make up for the difference. Past data seems to support this thesis. Historically, the spread between bonds and bunds tend to show an inverse relationship to dollar strength.

Widening Spreads Indicating A Bet Against the Dollar?

US EUR Spread

Given the recent strength of the USD, calls by the President for interest rate cuts and peak cycle economic reports all against the backdrop of an escalating trade war, are investors piling into negative yielding debt as an indirect bet against the US dollar?

Topics: Bonds

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