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Dollar-Denominated Debt Gets a Boost

Ahead of the ECB's impending bond purchases, global investors have been attracted to U.S. debt's higher all-in yields and purchasing-power protection as the U.S. dollar appreciates.

Dave Sekera: Fixed-income returns in February gave back some of the unusually strong returns generated in January as underlying interest rates rose. The Morningstar Core Bond Index, which is our broadest measure of the fixed-income universe, declined 85 basis points and is now only up 1.26%, thus far this year. Our Corporate Bond Index lost three quarters of a percent last month and is now only up 1.78%, year to date.

However, part of the increase in underlying yields was offset by tightening credit spreads. The average spread of the Morningstar Corporate Bond Index, our proxy for investment-grade bonds, tightened 16 basis points to end February at 133 basis points over Treasuries. In the high-yield market, the average spread of the BofA Merrill Lynch US High Yield Index tightened by 83 basis points to 443 basis points over Treasuries.

In the near term, we expect corporate bonds will continue to outperform Treasury bonds as credit spreads will likely continue to tighten. Later this month, the ECB will begin its own quantitative-easing program. As the ECB buys sovereign and structured-finance bonds, the proceeds will most likely be reinvested in the corporate-bond market. This demand should drive corporate credit spreads across both Europe and the U.S. tighter as this demand outstrips the new issue supply.

In anticipation of the ECB's impending purchases, global investors have been beginning to reallocate their portfolios into U.S.-dollar-denominated assets. These investors are seeing attractive value in being able to both pick up a higher all-in yield as well as protect the purchasing power of their principal as the U.S. dollar appreciates versus other currencies.

It's noteworthy that the five-year German bond was recently issued at a negative yield. This means that investors are locking in a loss if they hold those bonds until maturity. Fundamentally, this would only make economic sense if an investor is expecting a significant deflationary event, which would significantly reduce the value of other assets. Otherwise, the only way for an investor to make money on these bonds is to sell them to another investor at a price that locks in an even greater loss. In this case, speculators are expecting that they will be able to sell those bonds to the ECB, which has stated that it would consider buying debt trading at a negative yield.