Specific reasons vary from country to country, but analysts agree the shift in investor expectations has a lot to do with the growing sense that central banks realize the grand experiments with QE may have run their course. Last September, the Bank of Japan gave up its “ shock-and-awe” approach to stimulus in favor of targeting yield levels. Societe Generale says the European Central Bank will start scaling back its bond buying in October.
“The ECB and Bank of Japan debt purchases, even as the Fed stopped their quantitative easing, had been supporting bond markets” in the U.S., said Subadra Rajappa, the head of U.S. interest-rate strategy at SocGen.
Now, the simple fact that yields have flipped has persuaded some non-U.S. investors to bring more of their money home.
Asset managers in Japan yanked 1.07 trillion yen ($9.7 billion) from overseas debt securities in February, after sending a record 5.45 trillion yen abroad in July. The shift is far less pronounced in Europe, yet net fund outflows have also eased since surging to $717 billion in the 12 months ended September, data compiled by Deutsche Bank’s Slok show.
“Having more positive yields at the margin widens the opportunity set in Europe,” said Frances Hudson, Edinburgh-based global thematic strategist at Standard Life Investments, which oversees $360 billion. She said the firm trimmed its Treasuries allocation in the past six months because the U.S. is further along in the economic cycle as well as the rate cycle.
By one measure, coming to the U.S. might not be worth the hassle. After accounting for the cost to hedge against the dollar’s ups and downs -- a common practice for those that invest abroad -- 10-year Treasuries yield just 0.4 percentage point more than German bunds.
The turnabout is even starker for French bonds. They yield almost 0.3 percentage point more than currency-adjusted Treasuries. As recently as two years ago, hedged U.S. notes offered a 1.2 percentage point pickup.
For now, the unraveling of the reflation trade has helped to keep Treasury yields in check. But as the Fed lays the groundwork for unwinding its debt holdings, any pullback by foreigners could spell trouble.
“There is an under-appreciation in U.S. financial markets of the very, very significant role that rest of the world has played,” said Slok. If overseas investors retreat, “the U.S. will be hit.”
This article was provided by Bloomberg News.