Speaking of currency, foreign investors have to take U.S.dollar fluctuation risk when buying Treasuries. Currency has been a tailwind for overseas investors over the past year and the prospect of Fed rate hikes may help support the U.S. dollar going forward. The currency exposure may entice foreign investors as well.
FED OFFSET
It is common for short-term Treasury yields, such as the 2-year, to bear the brunt of changes to Fed rate hike expectations, as short maturities have historically been among the most sensitive. However, the pass-through to intermediate- and long-term Treasury prices and yields has been very limited in this rate hike cycle.
CONCLUSION
The knee-jerk reaction to low high-quality bond yields is to find them unappealing; but in an increasingly global world, perspective is important. While we believe the economy will ultimately improve from the current soft patch, with bond yields rising in response, longer-term Treasury yields may be slow to increase due to their relative attractiveness on a global scale. Higher yields provide another support to high-quality bond prices, in addition to ongoing concerns over the pace of global and domestic economic growth, China currency devaluation, energy and commodity industry impacts, and Fed rate hike risks. Negative interest rate policies at the ECB and BOJ mean that comparable international rates are even lower, making Treasuries a relative bargain compared with other high-quality government bond markets. Foreign investments in Treasuries may continue to keep a lid on yields for the foreseeable future.
Anthony Valeri is investment strategist for LPL Financial.