Sign of Inversion in US Treasury Bond Curve Dulls Investors Risk Appetite
Foreign investors are reviewing their investments or shunning Treasuries amid worrying sign of inversion in the US Treasury bond curve. Rates at the short end rise above those at the longer end and make it unprofitable for holders of these bonds to hedge their currency risks. Considering that short-term yields move higher than longer-term yields, the cost of hedging exposure to the US dollar has increased.
Institutional investors are reluctant to take on too much currency risk for regulatory reasons. The US-China trade war and possible slowdown of the US economic growth are also reasons for investors to lower, rather than raise, their risk exposure.
The difference between short-term and long-term bond rates, or the yield curve, has declined in recent weeks, as rising interest rates in the US meet growing doubts that the world's largest economy may slow down, which will affect return rates with a longer maturity.
The US Federal Reserve has raised rates eight times since late 2015, while the European Central Bank and the Bank of Japan have both kept interest rates below zero percent and the Bank of England has raised rates only twice from its record low near zero percent set in 2016 after the shock Brexit vote. As US short-term rates rise, currency forward markets which are closely linked to the differences in interest rates between currencies have moved to price in the higher cost of holding dollars.