European investors are ploughing money into higher yielding US bonds, buoyed by the divergence in central bank policy between the two regions.
So far this year, investors have poured $5.61bn into Europe-based, US exposed, bond exchange traded funds, almost double the previous annual record of $3.98bn, according to data provider Markit.
The rotation in fixed income flows across the Atlantic reflects a divergence between US and European monetary policy that has opened up a large gap between bond yields.
European investors are betting that the price of dollar-denominated bonds, which moves inversely to yields, already reflects the extent of an interest rate rise in the US, or that further appreciation of the dollar relative to the euro is likely to compensate them if the price of US bonds falls on the back of tighter monetary policy.
“Investors are thinking I can take a small bit of pain on my bonds if I make it back on the currency,” said Sean Taor, head of debt capital markets in Europe for the Royal Bank of Canada.
The European Central Bank is buying €60bn of bonds each month via a quantitative easing policy designed to suppress borrowing costs and bolster the economy and inflation expectations. In contrast, the US Federal Reserve is on course to shift official borrowing costs higher in the coming months, representing the first tightening of monetary policy since 2006.
Against that backdrop, US bond yields have risen since the start of the year, with Moody’s BAA rated corporate debt now yielding an average of 5.16 per cent, up from a low of 4.29 per cent in February.
Overall, US fixed income funds have been recording redemptions, according to EPFR, as investors anticipate a rate rise from the Fed lowering the face value of US debt.
Both Europe and the US have an underlying demand for the income provided by bonds, due to the pension requirements of an ageing society, said Roger Webb of Aberdeen Asset Management. “That being said you have seen some flows out of US bond mutual funds reflecting the proximity of the first rate rise by the Federal Reserve.”
However, falling prices and higher yields tend to tempt other investors back into the market. When German Bunds sold off at the end of April, “you saw other investors who were waiting on the sidelines because yields were too low stepping in”, Mr Webb said.
The spread between the current US 10-year Treasury yield of 2.20 per cent and the equivalent German Bund of 0.67 per cent is close to levels reached in March, which were the highest since 1990.
Earlier this year, the 10-year Bund yield almost touched zero in the wake of the ECB’s launch of QE, while the yields of shorter dated paper fell deep into negative territory.
At its current level, the 10-year Bund yields less than a quarter of its long-term average of 2.7 per cent, according to Markit.
Get alerts on Corporate bonds when a new story is published