Higher
US
interest
rates
could
well
tempt
investors
into
believe
investing
in
US
bonds
is
the
better
choice
right
now,
but
there
are
arguments
for
and
against
this
approach.
Economic
theory
would
have
us
believe
one
country
has
higher
interest
rates
than
another
because
of
differences
in
inflation
rates
and
economic
stability.
If
one
country
has
higher
inflation
than
another
(for
example,
inflation
in
Zimbabwe
is
almost
50%
year-on-year),
it
must
pay
higher
interest
rates
(150%
in
Zimbabwe)
to
attract
investors,
cool
off
the
real
economy,
and
compensate
for
the
risk
of
lending
money
to
it.
Nevertheless,
if
we
compare
the
US
with
Europe,
where
both
have
relatively
similar
inflation
data,
you
could
be
forgiven
for
wondering
why
Federal
Reserve
rates
are
now
at
5.25%,
while
the
European
Central
Bank
has
rates
at
4.5%.
See
the
chart
below.
True,
US
inflation
is
usually
higher
than
in
the
eurozone
(the
latest
February
CPI
data
for
the
US
put
year-on-year
inflation
at
3.2%.
In
the
eurozone
it’s
2.6%),
but
the
chart
below
shows
how
inflation
in
the
eurozone
reached
10.6%
in
October,
compared
to
a
peak
of
9.1%
in
June.
The
Fed’s
rates,
meanwhile,
were
always
higher
than
the
ECB’s.
It’s
therefore
difficult
to
explain
the
difference
in
central
bank
rates
simply
by
using
inflation
as
the
only
comparator.
The
answer
lies
in
the
difference
in
economic
strength
displayed
by
the
two
economies.
The
graph
below
shows
GDP
growth
rates
in
the
US
and
Europe
over
the
four
quarters
of
2023.
Clearly,
the
European
economy
was
much
weaker
than
the
US
economy.
Moreover,
US
growth
has
been
increasing,
while
eurozone
growth
has
been
going
in
the
opposite
direction.
Insofar
as
the
US
economy
can
afford
higher
rates
than
the
eurozone,
this
has
an
important
consequence
for
central
banks
–
hence
the
difference
in
interest
rates.
US
or
European
Bonds:
Which
Should
I
Choose?
The
big
question
for
investors
is
whether
there
is
a
way
to
benefit
from
higher
interest
rates
in
the
US.
That
applies
to
any
part
of
the
interest
rate
curve
(the
interest
rate
curve
is
the
graphical
representation
of
the
relationship
between
the
yield
or
interest
rate
of
a
country’s
sovereign
bonds
and
their
maturity).
Logically,
it
is
better
to
invest
in
a
bond
yielding
4.5%
than
in
a
bond
yielding
3%.
See
below.
It
would
then
be
more
interesting
to
invest
in
US
bonds
than
in
Eurozone
bonds
as
they
offer
higher
yields.
But
there
are
two
further
considerations
to
account
for.
How
Does
Currency
Risk
Affect
my
Bonds?
Yes,
US
bonds
pay
more
interest
than
European
bonds,
but
the
European
investor
has
to
take
a
dollar
risk,
which
can
be
beneficial
or
detrimental.
For
example,
if
we
compare
two
exchange-traded
funds
–
such
as
the
iShares
€
Govt
Bond
1-3yr
ETF
EUR
and
the
iShares
$
Treasury
Bd
1-3y
ETF
USD
–
which
invest
in
the
same
tranches
of
the
interest
rate
curves,
one
in
the
Eurozone
and
the
other
in
the
US.
If
we
compare
their
performance
in
euros
over
the
last
12
months,
there
is
a
significant
difference,
as
can
be
seen
in
the
chart
below.
How
Can
I
Hedge
Dollar
Risk
in
Bond
Investing?
One
option
is
to
hedge
the
dollar
risk,
where
possible.
Many
dollar
bond
funds
tend
to
have
a
euro
hedged
class,
which
means
they
do
not
assume
they
immune
from
currency
fluctuations.
However,
hedging
dollar
risk
costs
money,
and
the
cost
is
the
interest
rate
differential
between
the
dollar
and
the
euro,
eliminating,
at
least
in
part,
the
supposed
advantage
of
investing
in
the
US
because
of
its
higher
interest
rates.
In
fact,
if
we
compare
the
performance
of
an
ETF
such
as
the
iShares
Euro
Government
Bond
1-3
Year
(a
European
government
bond
ETF
with
maturity
between
1
and
3
years)
and
the
iShares
USD
Treasury
1-3
Year
EURH
(a
US
government
bond
ETF
with
maturity
between
1
and
3
years
and
with
the
currency
hedged)
over
the
last
12
months,
it
is
the
European
government
bond
ETF
that
achieves
the
best
return.
Why
is
the
European
debt
ETF
more
profitable
than
the
Euro
hedged
US
debt
ETF
that
invests
in
the
same
part
of
the
curve?
There
may
be
small
differences
in
the
duration
of
the
portfolios
of
these
two
ETFs,
but
they
are
minimal.
What
there
are,
however,
are
differences
in
the
evolution
of
rates
in
the
US
and
in
Europe
within
the
same
part
of
the
curve.
For
example,
the
attached
chart
illustrates
how
2-year
bond
rates
on
both
sides
of
the
Atlantic
have
varied
over
the
past
12
months.
They
are
not
identical
movements
and
this
leads
to
different
yields.
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