Last month, yields on U.S. 10-year notes turned negative for Japanese buyers who pay to eliminate currency fluctuations from their returns, something that hasn’t happened since the financial crisis. It’s even worse for euro-based investors, who are locking in sub-zero returns on Treasuries for the first time in history.
Ten-year yields in the U.S. are currently 0.23 percentage point below a basket of bonds from Australia, France, Germany, Italy, Japan, Spain and Switzerland on a hedged basis, versus 1.4 percentage points above on an unhedged basis, according to data compiled by BlackRock. At the start of the year, hedged Treasuries yielded over a half-percentage point more.
In Japan, where 10-year government bonds yield less than zero, the advantage for Treasuries has dwindled from a percentage point at the start of the year to less than 0.1 percentage point now. Without much added value for overseas investors, it’s harder to see foreign demand driving Treasuries to new records, especially as the Federal Reserve moves toward gradually raising rates.
But now, because the rate has turned negative, they’re effectively paying interest to lend the yen, which eats into their bond returns. That’s on top of the Libor rate they’ll need to pay for borrowing the dollars, which currently stands at 0.79 percent over three months. The basis, as it’s known, is currently minus 0.62 percentage point for yen-based investors, which is close to the most expensive in five years. For those with euros, the basis is minus 0.42 percentage point. That’s more than twice as costly as the average over the past three years.