Investors looking to diversify their fixed-income portfolios have plenty of reasons to consider investing in a range of non-U.S. debt securities in 2017.
The U.S. Federal Reserve’s monetary policy cycle continues to be well ahead of other global central banks’, with a significant ongoing interest-rate differential. Add to that a relatively stable U.S. dollar and foreign currency exposure looks more like a potential source of additional earnings rather than a risk or liability.
Further, the decades-long trend of the U.S. economy acting as a major engine of the global economy, bolstering relative weakness elsewhere, could be reversing. The pace of U.S. growth remains moderate and the U.S. credit cycle is starting to show signs of aging while economies in Europe, Asia, and Latin America are gaining strength.
Interest rate trends favorable
“Interest rates around the world are still falling,” says Hemant Baijal, co-head of OFI Global’s Global Debt team. “India, Indonesia, Russia, Brazil, and Colombia have all cut interest rates. Only the U.S., Mexico, and Turkey have raised rates, and we believe Mexico’s rates will peak much sooner than the U.S. and begin to come down.”
[Should illustrate the 10yr sovereign yield trends across the countries above]
The Fed has raised the federal funds rate three times since December, pursuing a steady, gradual increase in short-term U.S. interest rates that could continue for a couple of years. The benchmark rate, currently 1.25 percent, is projected to rise to 3 percent in 2019.
Although longer-term interest rates haven’t risen materially yet, the yield on the 10-year U.S. Treasury bond rose from 1.82 percent to 2.60 percent in the weeks after the presidential election in November, along with expectations of a pro-growth Trump fiscal policy. As of late June, the 10-year bond remained above the 2 percent mark, after moderating during the spring of 2017.
In contrast, as of late June, the German and Japanese 10-year government bonds yielded just over 0.25 percent and 0.05 percent, respectively, while the U.K. 10-year government bond yielded roughly 1 percent.
U.S. dollar’s rally near end?
Foreign-exchange currency moves may be difficult to forecast with precision, but the U.S. dollar’s trend line versus the euro since November shows an abrupt rise to €0.95 per $1 U.S. in late December before falling in stages to €0.89 by late June.
“While there are opportunities to extract value from hedging the dollar when the U.S. currency is rising, we believe it is close to peaking if it has not peaked already,” Baijal notes. “In this sort of environment, U.S. investors can boost their returns from dollar depreciation or at least face reduced volatility from stability in the dollar.”
Non-U.S. economies recover while U.S. credit risks rise
While the latest U.S. economic data isn’t setting off any alarm bells, U.S. GDP expanded at an annualized pace of just 1.4 percent in the first quarter of 2017 after a 2.1 percent annual growth rate in the fourth quarter of 2016. Meanwhile, Eurozone GDP grew an annualized 1.8 percent while the emerging markets grew 4.5 percent in the first quarter.
Aside from overall rates of regional economic growth, the credit environment is healthier in Europe as well. “Europe’s double-dip recession has led businesses to manage their balance sheets more conservatively than in the U.S., where animal spirits were stirred earlier,” says Chris Kelly, co-head of OFI Global’s Global Debt team. “And the availability of cheap money in the U.S. has led to much more active use of financial engineering, typified by share buybacks and dividend payouts.”
Kelly notes that “hot spots” of increasing risk within U.S. credit sectors are materializing for auto loans and retail credit as well as for commercial real estate, notably in the retail sector.
In contrast, “we’re not seeing that in Europe and the emerging markets,” Baijal notes.
Overall, relative to the U.S. credit markets, non-U.S. fixed income currently presents a range of attractive opportunities, taking into account credit risk, foreign-exchange risk, and interest-rate risk.
“Over the next 18 to 36 months, we believe the U.S. dollar will be stable to lower,” Baijal adds, “and in an environment in which the Fed is increasing rates while other central banks aren’t, we see the rest of the world –– rather than the U.S. economy –– as driving growth. And capital generally will tend to flow where the rate of growth is the highest.”
OFI Global is not affiliated with Institutional Investor.
Foreign investments may be volatile and involve additional expenses and special risks including currency fluctuations, foreign taxes, and geopolitical risks. Emerging- and developing-market investments may be especially volatile. Value investing involves the risk that undervalued securities may not appreciate as anticipated.
OFI Global Asset Management (“OFI Global”) consists of OppenheimerFunds, Inc., and certain of its advisory subsidiaries, including OFI Global Asset Management, Inc.; OFI Global Institutional, Inc.; OFI SteelPath Inc.; VTL Associates, LLC; and OFI Global Trust Co; SNW Asset Management, LLC. The firm offers a full range of investment solutions across equity, fixed income, and alternative asset classes. The views herein represent the opinions of OFI Global and are subject to change based on subsequent developments. They are not intended as investment advice or to predict or depict the performance of any investment. The material contained herein is not intended to provide, and should not be relied on for, investment, accounting, legal, or tax advice. Further, this material does not constitute a recommendation to buy, sell, or hold any security. No offer or solicitation for the sale of any security or financial instrument is made hereby.