Why are international bond yields so low? Or put another way, why are US bond yields so high?

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lyrictulip
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Why are international bond yields so low? Or put another way, why are US bond yields so high?

Post by lyrictulip » Thu Oct 05, 2017 7:54 am

As I consider my international bond allocation (which I know is a controversial topic, that I don't mean to get into), I'm struck by the disparity between international bonds / BNDX (Average Effective Maturity 9.2 years, yield to maturity 0.8%) and US bonds / BND (8.3 years, 2.39%).

Assuming some overarching "law of one price" governing the cost of debt, why is there such a disparity- and in particular, am I wrong in interpreting this disparity as suggesting that the market views US aggregate debt as significantly riskier, on average, than international debt?

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in_reality
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Re: Why are international bond yields so low? Or put another way, why are US bond yields so high?

Post by in_reality » Thu Oct 05, 2017 8:04 am

Isn't BNDX expected by Vanguard to return exactly the same as BND?

Vanguard says one should be indifferent to hedged international bonds as the hedge return will make them equivalent.

I don't think risk has as much to do with it as currency expectations do.
[60% US _ 26% DEV _ 14% EM] | (-16% LC _ +8% MC _ +8% SC) | [47% FND/VAL _ 40% MKT _ 7% MOM _ 6% REIT] | (+/- 5% or *25% rebalancing bands)

z3r0c00l
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Re: Why are international bond yields so low? Or put another way, why are US bond yields so high?

Post by z3r0c00l » Thu Oct 05, 2017 9:52 am

Differences in inflation and currencies explain most of it. Looking at bond yields in isolation, without considering inflation, is almost meaningless.

not4me
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Re: Why are international bond yields so low? Or put another way, why are US bond yields so high?

Post by not4me » Thu Oct 05, 2017 1:03 pm

lyrictulip wrote:
Thu Oct 05, 2017 7:54 am

Assuming some overarching "law of one price" governing the cost of debt, why is there such a disparity- and in particular, am I wrong in interpreting this disparity as suggesting that the market views US aggregate debt as significantly riskier, on average, than international debt?
I'm far from being the most knowledgeable on this & I'm not aware of the "Law" you cited. I'll also zero in on using the singular "market". At a real basic level, to me the price for a given bond will be driven by supply & demand. Which leads to questioning whether US aggregate debt has the same balance of supply/demand as international.

I'd start by looking in two areas that I think are somewhat related. It will boil down to credit quality. BND often is heavily allocated to US Government, which I assume is absent from BNDX. Outside the US, are governments seen the same as US? I would think typically it would be the opposite of what you highlighted. But keep in mind the central bank "demand". Don't know about today, but for a while I think both Japan & Germany had fallen into negative yield territory due largely to intervention. I also am not sure that non-government issuance of bonds outside the US is at a level that it is in the US. For example, are corporations outside the US relying on debt in their capital structure (especially relative to government issuance) to the same extent as inside the US?

I may be way off base & really have no sources to cite to authenticate my guess. Hope someone else weighs in with more facts than I

alex_686
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Re: Why are international bond yields so low? Or put another way, why are US bond yields so high?

Post by alex_686 » Thu Oct 05, 2017 1:11 pm

not4me wrote:
Thu Oct 05, 2017 1:03 pm
I'm far from being the most knowledgeable on this & I'm not aware of the "Law" you cited.
It is an economic theory which requires markets to be frictionless. It is almost never true but it is useful in figuring out where inefficiencies lie. A fun example is The Economist Big Mac index. Also read up no "No Arbitrage Principle"

Your suggestion of credit quality is valid, as is inflation. We can also point towards home market basis, different treatment of taxes, and regulations that require institutions to hold long dated government debt.

not4me
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Re: Why are international bond yields so low? Or put another way, why are US bond yields so high?

Post by not4me » Thu Oct 05, 2017 1:21 pm

alex_686 wrote:
Thu Oct 05, 2017 1:11 pm
not4me wrote:
Thu Oct 05, 2017 1:03 pm
I'm far from being the most knowledgeable on this & I'm not aware of the "Law" you cited.
It is an economic theory which requires markets to be frictionless. It is almost never true but it is useful in figuring out where inefficiencies lie. A fun example is The Economist Big Mac index. Also read up no "No Arbitrage Principle"

Your suggestion of credit quality is valid, as is inflation. We can also point towards home market basis, different treatment of taxes, and regulations that require institutions to hold long dated government debt.
Thanks -- good explanation. I actually have heard of it, but didn't recall that being the name.

I know money flows to where it is treated best & understand the affect that can have over a longer time period. In my mind, I don't think of THE debt market as singular...especially when central banks are active in their respective areas.

lack_ey
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Re: Why are international bond yields so low? Or put another way, why are US bond yields so high?

Post by lack_ey » Thu Oct 05, 2017 1:23 pm

You're missing the hedge return in the international bond fund. When you hedge let's say Euros to USD with 1-month forward contracts like the fund does, you agree to get X dollars for Y Euros in a month. That ratio of X/Y is not the current exchange rate (spot). If you think about it, short-term interest rates are higher here, and over a month you could for example just invest in a 4-week Treasury bill and earn about 1%, while you'd get negative over there. So naturally we get a discount on the exchange rate we're locking in, to account for this discrepancy in short-term rates that is current and expected over the period. Otherwise, there'd be some easy ways to make money on these kinds of transactions.

US short-term rates are higher than in most of the countries that the international bond fund invests in, hence the fund receives what's currently a positive hedge return from hedging the FX exposure. This is not included in the yield figures such as SEC yield.

Check this Vanguard piece for some info:
https://personal.vanguard.com/pdf/ISGHC.pdf

As such the difference is not as large as it seems at first glance. Under some further assumptions maybe the expected return is close to equivalent given the starting conditions.


Now, even if you don't hedge the FX exposure, based on expected inflation and changes in exchange rates, the expected returns may again be closer than you are implying. You can read about uncovered and covered interest rate parity.

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