Why are US bonds paying more than EU

[RetireBy90]

I've been trying to understand lately why an investor would buy a euro bond at 0% when they can buy a US bond at say 1.5%.

So there could be several reasons I can think of:
1) They think that dollar will weaken. So they spent EU 884 to buy a bond at $1,000, at exchange rate of 1.13, but they don't think they will get the same exchange rate in 10 years, so the $1,000 will only equate to say EU800 at exchange rate of 1.25. So they demand a higher rate to compensate for loss in exchange rate.
2) They get other benefits like no taxes on Euro bonds or want to support their country not ours.
3) They know ECB is buying bonds so they think face value of Euro Bonds will go up.
4) They think that growth rates or GDP in EU will be better than in US - not sure how this would affect the bonds, perhaps through changes in exchange rates.
5) They think that inflation in EU and US will be different. Again, I don't really have any idea how this would affect the bonds except perhaps through changes in exchange rates.


So my question is how would changes in growth rates or inflation affect the returned principal if they bought a US bond rather than a EU bond. This would assume that both US and EU bonds have 0 risk of default.

Thanks in advance for any ideas

 

[highlow65]

I think the main thing involved is that growth expectations are higher in the U.S than Europe today. At least this is what the talking heads on CNBC say.

 

[RetireBy90]

I think the main thing involved is that growth expectations are higher in the U.S than Europe today. At least this is what the talking heads on CNBC say.

So how would this impact the expected return? I could see higher growth causing the dollar to be stronger, which would mean more Euro/yen when you convert your principal or dividend back to local currency, but then wouldn't you accept a lower rate for dollar bonds? Sorry if I'm being dense, just trying to understand

 

[highlow65]

Another reason is European Central Banks are buying way more bonds than U.S central banks. We have easy money here right now but not to the extent of Europe or Japan. The zero interest rates there are hoping to get companies to spend and invest. This helps to prop up equities but hurts savers and can really hurt pension plans and insurance companies, Its a trade off and there is a very good chance equities will take a big hit if interest rates increase. Hope this helps but not totally answering your question. Any economists out there?

 

[harley]

Answering this question would require 1) understanding bonds, 2) understanding investors, and 3)understanding the EU economy. So, sorry. Can't help.

 

[jazz4cash]

Something I wanted ask also. I don't expect a rational answer for the discrepancy which is HUGE.
10 yr US is 1.69
10 yr Ger is 0.29
10 yr Jpn is -0.048

Looking forward to opinions of the bond experts on here.


Sent from my iPhone using Early Retirement Forum

 

[Mulligan]

All I know is this...Can you imagine how great the economy would be if families could monetize their debts like governments are doing? My purchases would never end!

 

[Fermion]

All I know is this...Can you imagine how great the economy would be if families could monetize their debts like governments are doing? My purchases would never end!

Not only monetize the debts, but get a rebate on the interest they are charged in the form of taxes.

Even the 1.5% is only 1% for the USA because they charge 38%+ tax on the interest they pay (to the wealthy). What a deal, especially with inflation at 2%. The more money they loan out the better.

 

[MichaelB]

All I know is this...Can you imagine how great the economy would be if families could monetize their debts like governments are doing? My purchases would never end!

The gov'ts mentioned in the OP - EU & US - are not monetizing debt. Not sure if Japan is starting to go down that road, bit if so, it is still very early.

 

[Lsbcal]

Something I wanted ask also. I don't expect a rational answer for the discrepancy which is HUGE.
10 yr US is 1.69
10 yr Ger is 0.29
10 yr Jpn is -0.048

Looking forward to opinions of the bond experts on here.

I am not a bond expert. My guess is that the answer lies partly in expected inflation rates. That would be because what one really gets is the real return. So I would guess the US inflation is projected to be maybe 1% (very roughly) above German inflation. I don't know if there is a German equivalent to US TIPS to check this out. Anyway, there are also secondary considerations mentioned by the OP.

If you look at the implied inflation of US 10yr Treasuries it is roughly:
10yr Treasury - 10yr TIPS = 1.71 - 0.61 = 1.1%

Germans abhor inflation because of what happened in the 1930's. The US abhors deflation because of what happened in the 1930's. We are much more prone to pushing for growth at the expense of inflation. Whether this is good is not the point, it is something to deal with pragmatically.

 

[Lsbcal]

...

So my question is how would changes in growth rates or inflation affect the returned principal if they bought a US bond rather than a EU bond. This would assume that both US and EU bonds have 0 risk of default.

Thanks in advance for any ideas

Now I reread the OP and noticed that I haven't really tried to get at the answer, sorry.

As a US investor I do not want to take currency risks with bonds. So I only buy US bonds. Now I know that foreign hedged bonds are even suggested by Vanguard. But I view bonds as a place for (1) principal safety, (2) maybe a bit of real return like 1% in the intermediate future (could be zero though).

I would say that a German would think like this too about their situation. Clearly if US inflation were above German inflation by more then is already built into the relative rate assumptions, the US bond would be a bad bet. As a German individual I would think you would be less inclined to take the risk. Plus I've read that German's tend to be more risk adverse in their investing in general.

Oh well, I'm nattering on and maybe I've hit the mark or ... not.
Clearly a perfect answer to this would involve an equation with variables like growth rates, etc.

 

[Lsbcal]

Answering this question would require 1) understanding bonds, 2) understanding investors, and 3)understanding the EU economy. So, sorry. Can't help.

A wiser man then myself.

 

[Mulligan]

The gov'ts mentioned in the OP - EU & US - are not monetizing debt. Not sure if Japan is starting to go down that road, bit if so, it is still very early.

True, but only because they "say they arent". Two types.. Temporary and permanent. They are on record as saying they will unwind, but we haven't seen this yet. They are taking the interest and returning to treasury which is close to walking and quacking like a duck though. Temporary sure is going on for a long time!

https://www.stlouisfed.org/publicat...ng-2013/is-the-fed-monetizing-government-debt

However, what is usually meant by “monetizing the debt,” Andolfatto and Li write, is the use of money creation as a permanent source of financing for government spending. Therefore, whether the Fed is truly monetizing government debt depends on what the Fed intends to do with its portfolio in the long run.

 

[Totoro]

So my question is how would changes in growth rates or inflation affect the returned principal if they bought a US bond rather than a EU bond. This would assume that both US and EU bonds have 0 risk of default.

Thanks in advance for any ideas

To answer the question: If you buy bonds and wait until maturity, nothing will affect your return in that currency. It's locked in the moment you buy it.

What you have is currency risk though. If you have USD expenses, having bonds in EUR will cause a mismatch. If EUR goes up, good for you, if down, shucks.

Now, first realize that in a market where capital can flow relatively free, you can either control interest rates or currency rates. As interest goes up, currency typically goes down and vice versa. It's one of the reasons why the USD has been going up vs. the EUR. Currency typically goes down because less investors want a low yielding bond. Sometimes they even borrow in the low interest currency, to invest in the high yielding one (carry trade - Japan is a good example).

Now then, why are interest rates lower in EUR than the US? Mainly because of low growth, which has led the central banks to push down interest rates by buying loads of bonds. They want low interest rates to stimulate borrowing, ease debt loads and get industries and consumers to invest. First they lowered the interest rates, then they started creating money out of thin air and buy back bonds with that. Added benefit is that it should stimulate inflation.

Result: low bond rates, low interest rates. The USA did the same but growth has picked up lately, so the central bank buying has stopped and interest rate hikes might be coming. Europe is still buying as much as they can.

Now, your first question was: why on earth buy EUR bonds when you can buy USA ones?

Some of your reasons are valid ones, here's my top-suspicions list :

1. Because they have to. Lots of funds and banks (savings accounts) have money invested (deposited) in EUR and have to invest in EUR. Local governments, pension funds, bond funds with a certain mandate, companies with liquidty excesses, etc ..
2. Currency risk: I invest in EUR CDs because my expenses are in EUR, and have no idea what USD will do in the future
3. They are the ECB. Basically reason #1
4. Fear. A typical EU citizen won't invest easily in another country, let alone currency. They rather complain about the low interest rates.

Other valid reasons are speculation related (and which you mentioned):

1. Gambling on the ECB: you think they'll keep buying, which will push bond prices up even more. Hedge fund tactic and bond speculators.
2. Currency speculation on the hopes of short term economic recovery: if you buy short term bonds (or cash), a raising interest rate won't hurt you alot. A raising interest rate does push the currency up. Note you can't do this trick with long term bonds as the loss of value (due to interest rates rising) will very likely destroy a currency rate advantage.

No specialist either, so two pinches of salt do apply

 

[gcgang]

I've been trying to understand lately why an investor would buy a euro bond at 0% when they can buy a US bond at say 1.5...

3) They know ECB is buying bonds so they think face value of Euro Bonds will go up....

Thanks in advance for any ideas

I think this one is called " the greater fool theory".

There doesn't seem to be much value in any of the bond options nowadays.

If you're lending out your money and agreeing to get paid back less, you must fear the value of everything else is REALLY going to drop.

 

[VFK57]

My guess is that most investors main concern is to preserve the value of investment and earn best possible return. We know that riskier investment always pays higher than average return to attract money. Yet many prefer tiny or no return in exchange for safety of investment. At this point I am not sure what is safest currency as Euro has its own problems. However I invest in US$ and most Europeans stay with Euro. Just a guess.

 

[Sunset]

For the average Joe, I think it's just very unknown, scary and possibly even hard. Plus there are extra expenses.

I've often thought why not invest in the Indian 10yr bond: 7.59%

Seems like a better deal than EUR or USD.

 

[Totoro]

Inflation in India his running at ~6%, and was 10% not so long ago.

No surprise: the Rupee dropped by half in value vs the USD in a few years.

So that's why.

 

[VFK57]

A little over two years ago I had seen an advertisement from Ukrainian central bank, offering 8℅ rate on the US$ investment. Now Ukraine is bankrupt and asked many creditors to right off portion of the loans and restructure remaining loans. Risky investments are always pay highest return initially.

 

[jazz4cash]

Risky investments are always pay highest return initially.

So you're saying US bonds are riskier than EU and Japan?


Sent from my iPhone using Early Retirement Forum

 

[VFK57]

So you're saying US bonds are riskier than EU and Japan?


Sent from my iPhone using Early Retirement Forum

US bonds are not that high, if you know the Government insured bonds at 7 - 8℅ please let us know.

 

[jazz4cash]

No I think you misunderstood my point.


Sent from my iPhone using Early Retirement Forum

 

[Sunset]

No I think you misunderstood my point.
.....

I think, the reason you find US bonds higher that EUR or JP bonds is there is an expectation that the USD which is high will come down, so for foreigners that invest in US bonds the currency risk is higher than investing in their own bonds.

For Americans, investing in US bonds carries no currency risk, unless you are very rich where you have lots of choice and millions to invest, then you see the risk and expect to be compensated.

So in a sense, some people feel the US is risky compared to EUR or JP.

 

[jazz4cash]

So here's something that expands on Sunsets suggestion above.
https://www.quora.com/Why-do-US-T-B...he-government-bonds-of-the-European-countries


Sent from my iPhone using Early Retirement Forum

 

[Totoro]

I think, the reason you find US bonds higher that EUR or JP bonds is there is an expectation that the USD which is high will come down, so for foreigners that invest in US bonds the currency risk is higher than investing in their own bonds.

As a EUR citizen, It's not even the expectation that the USD might go down.

It's the certainty that I cannot predict what will happen, be it up, down or sideways.

And a little bit of taxation issues - but that's a different story.