US Credit Draws In Foreign Investors Eying Lower Costs to Hedge

Foreign investors have been buying more US corporate bonds, a trend that will likely continue as Federal Reserve monetary easing lowers the cost of hedging and investors hunt for yield.

Holdings of the debt by overseas investors jumped 10% year-over-year as of the second quarter, to nearly $4 trillion, JPMorgan Chase & Co. analysts Eric Beinstein and Nathaniel Rosenbaum wrote in a report last month. They see the future attractiveness of US high-grade bonds to this buyer base rising as Federal Reserve rate cuts reduce hedging costs.

For investors in Europe and Asia, lower hedging costs can keep yields from US bonds relatively high in their local currencies even if the Fed is cutting rates. These buyers could become a key source of funds in the future if lower yields end up reducing demand from pensions and insurance companies. At the same time, investors seeking relatively higher yields now are drawn to the US, which began cutting rates after most other developed economies.

“We believe a significant driver of this activity is the fact that most overseas investors were cognizant that the same Fed easing that is driving HG yields lower is also just as likely to drive hedging costs lower too over time,” the strategists wrote.

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At the same, the yield curve is expected to steepen as short-term borrowing costs drop and fears of recession diminish, making fixed income attractive. Many people who haven’t invested in credit or those that want more exposure are likely to act now, before yields get lower.