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May 2024 / VIDEO

The benefits of hedged diversification

Non-US bonds currently offer higher yields on a currency-hedged basis


Investment-grade bond returns for U.S. investors have been subpar over the past year, with the Bloomberg U.S. Aggregate Bond Index posting a negative return of -0.83% over the year ended April 23, 2024.

This loss was primarily due to rising interest rates, which were driven higher by stubborn inflation and a consequently more hawkish U.S. Federal Reserve. Over the same period, the 10-year U.S. Treasury yield increased from 3.53% to 4.59%.

U.S. investors who diversified their bond exposure to include non-U.S. investment-grade bonds also have suffered. Over the year ended April 23, the Bloomberg Global Aggregate ex-USD Bond Index posted almost a 3% loss. But this subpar performance was primarily due to the strength of the U.S. dollar, as the currency translation effect negatively affected returns on bonds denominated in other currencies.

For those investors who chose to diversify their bond exposure with currency-hedged non-U.S. bonds, the results were much more satisfying. Over the same time period, the currency-hedged version of the Bloomberg Global Aggregate ex-USD Bond Index returned a positive 5.59%. 

And there are reasons to believe this trend could continue.  Notably, many global bonds currently offer superior hedged yields relative to their U.S. counterparts. Additionally, interest rates outside of the U.S. could be poised to move in a more favorable direction, as many non-U.S. central banks are widely expected to cut interest rates more than the Fed during the remainder of 2024.

U.S. bond yields generally are higher than the yields in other developed markets. We can observe this by comparing 10-year sovereign bond yields across various countries. Almost all developed market yields are lower than the U.S. yield in local currency terms.   

But this is not the case when the benefits of U.S. dollar hedging are factored in. By hedging their local currency exposure, U.S. dollar-based investors can increase the effective yield on nondollar bonds. Once this is factored in, the picture changes considerably—giving many non-U.S. sovereigns a yield advantage on a hedged basis.

The direction of interest rates outside of the U.S. also could prove more favorable for bond investors. This is because inflation appears to be less of a concern in many other countries.

For instance, while the U.S. inflation expectations have risen steadily so far in 2024, inflation expectations for the eurozone have fallen modestly. As a result, the European Central Bank has less reason to keep interest rates at their current levels, whereas the Fed may be forced into a “higher for longer” stance until inflation expectations begin to moderate.

These divergent paths can be illustrated by examining futures market pricing for the Fed versus the ECB. On January 12, 2024, futures markets priced in a 1.68 percentage-point reduction in the U.S. federal funds rate by the end of the year, while the ECB was only expected to cut by 1.53 percentage points over the same period. But, as of April 23, the Fed was expected to cut by only 0.44 percentage points, while the ECB was expected to cut by 0.76 percentage points.  

Given the currently superior effective yields on hedged nondollar bonds, and more promising expectations for non-U.S. developed market central bank rate cuts, our Asset Allocation Committee recently increased its exposure to hedged non-U.S. bonds in our U.S.-based multi-asset portfolios.


This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

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