The Unexpected Value in Non-USD Bonds
Quality non-USD bonds remain attractive
Chief Investment Office, Daryl Ho31 Aug 2023
  • Significant hedging gains under cross-currency swap arrangements of AAA-AA rated government bonds
  • This has resulted in yield pickups that make US treasuries pale in comparison
  • Such domestic bonds would become increasingly attractive for investors with a home-currency bias
  • USD bonds may see greater supply from issuers taking advantage of the CCS basis
  • Local currency bonds could be a good opportunistic play
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All eyes on BRICS. The recent BRICS summit in Johannesburg saw more than 60 countries in attendance, and expansion was all but certain with the invitation of new member states – Argentina, Ethiopia, Iran, Saudi Arabia, Egypt, and the UAE into the club. Despite obvious diplomatic challenges compared to the more unified democracies of the G7 bloc, the summit nonetheless elicits provocative notions of USD decline, transitions to a multipolar world order, and local currency settlement of commodities trade. From a fixed income perspective, does this geopolitical transition paint a rosy picture for the future of local currency bonds?

Non-USD bonds already in vogue. Certainly, should net settlement in trade be conducted in non-USD terms, it would naturally rouse global reserve managers to hold more non-USD currencies, a tailwind for non-USD bond flows in the long run. Yet one need not even wait that long to notice the obvious advantages of such bonds today. High short-term US rates have resulted in significant hedging gains under cross-currency swap (CCS) arrangements of a broad swathe of AAA-AA rated government bonds into USD, resulting in yield pickups that make US Treasuries pale in comparison. For the uninitiated, a CCS for a non-USD bond involves selling future cash flows in local currency for USD using FX forward rates; current gains are predicated on expectations that the USD would depreciate against these currencies.

Figure 1: US Treasuries losing their shine against USD-hedged domestic bonds

Source: Bloomberg, DBS
Note: Yields are approximated via 3-month FX hedges

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