Does anybody actually hedge their dollar risk? And some Fed news

US goverment bonds, otherwise known as the least worst promise in global credit markets are currently yielding 2.63% on the 10 year.

Two years ago this article reported,

Benchmark U.S. 10-year notes, for example, yield 1.54 percent, while comparable German bond yields are negative 0.08 percent and Japanese 10-year notes yield negative 0.02 percent.

As of today German 10 year Bunds are yielding 0.16% and JGB’s yield -0.02%.

Of course it is somewhat generous to call the bond markets “markets” as genuine price discovery hasn’t taken place in around 10 years due to an orgy of central bank buying and loose monetary policy. As an interesting (to me at least) side note I recently learnt that the Swiss National Bank has a $90 Billion portfolio of US stocks. It got this by printing Swiss francs in order to try to keep the franc from appreciating too heavily and then used this newly minted money to make Jeff Bezos and Tim Cook richer. It has to be said that the SNB is a slightly unusual central bank and I don’t fully understnad its workings so maybe I should dial down the outrage!

But back to the matter at hand, here are some direct quotes from [1] telling us that the disparity in yields from local to US isn’t as attractive as it first looks for international investors and that these poor global investors are feeling some pain.

Recently, however, the yield pick-up has disappeared, as the cost of hedging the foreign exchange risk of the bonds using short-dated forwards has increased, Deutsche Bank strategist George Saravelos said in the report, sent on Monday.

“There now isn’t any global fixed income investor that can make decent money by buying hedged U.S. Treasuries,” he said.

This problem has probably got worse as the cost of hedging their dollar risk has only got more expensive because of the interest rate differentials. So as investors that are feeling some pain are prone to do, they are ignoring the problem

Foreign investors seeking U.S. government debt will now need to buy the bonds unhedged for the trade to be profitable, or turn to higher-risk bonds such as corporate debt to generate income, Saravelos said.

This (unhedged) trade has worked out well for european investors with the strong dollar, weak euro and death-spiralling pound SO FAR. Indeed in 2016, unhedged british investors in the S&P 500 made a healthy return of around 40%! Because of the circa 20% rise in the underlying and the circa 20% fall in sterling.

What does this mean? Well if I am being honest I am not sure but if the dollar were to weaken substantially against the G7 currencies then I would expect the losses on these unhedged bond trades to provoke some serious selling of US treasuries which would push up yields (bond prices and yields move in opposite directions).

There is massive issuance of US debt as the Trump administration spends money like the Donald is running his favourite bankrupt casino in Atlantic city. So it seems that a lack of supply will not be a problem.

Demand for treasuries also seems healthy as 10 year yields have fallen from a high of 3.24% on 8/11/2018 due to volatility in equity markets, worries of an economic slowdown and with the Fed potentially pausing the monthly runoff of treasuries the outlook is uncertain.

Politics in Washington will most likely also have an impact. Could the democrats do what the Republicans did in 2011 with the debt ceiling? That seems unlikely. Maybe the debt hawks in the Republican party could cause trouble but they seem to be hypocrites when they run things.

Our debt is out of control. What was a fiscal challenge is now a fiscal crisis. We cannot deny it; instead we must, as Americans, confront it responsibly. And that is exactly what Republicans pledge to do. - Paul Ryan during the Obama years

One possibility is that Trump and the Democrats get together to do some infrastructure investment which I could imagine as he gets late on in his first term, poll numbers declining abandoned by FOX news and sulking in the White house desperate for some positive news coverage.

I wouldn’t at all be surprised if yields were to fall from where they are today over 2019 even as the deficit hawks make loud noises. It is worth keeping an eye on what Jeffrey Gundlach is saying.

Other Fed news

In other news Fed chair Powell shows us his patient streak. Which is unsurprising since he is a Tesla owner.

Patient Powell

He said,

We’re listening carefully with … sensitivity to the message that the markets are sending and we’ll be taking those downside risks into account as we make policy going forward.

Thats always nice to hear.

We don’t believe that our issuance is an important part of the story of the market turbulence that began in the fourth quarter of last year. But, I’ll say again, if we reached a different conclusion, we wouldn’t hesitate to make a change. [2]

Yeah, sure so are we back to the good times?

Party Yellen

In my opinion he does have a point. The internals of the equity markets (especially the cyclicals, housebuilders, autos etc) have been sending a message that consumers and corporates are struggling with these higher rates. Not my analysis but Stanley Drukenmiller’s.


Although you could argue that he has capitulated to the market in a way reminiscent of a North Korean show trial confession video. I think he was even reading from a script! The bull market staggers on…



Written on February 1, 2019