Bond Investors Get More Bang for Their Buck in Japan Than U.K.

(Bloomberg) -- Dollar-based investors are now getting caught up in the Japanification of the U.K. bond market.

For U.S. investors who hedge their portfolios against currency moves, two-year U.K. notes return just about a third of Japanese government bonds. That's a far cry from a year ago, when they could lock in 2.96% on either 30-year gilts or similar-maturity JGBs. The disparity in that segment is now 26 basis points, thanks to a slump in sterling forward points and gilt yields.

Gilt yields have been on a decline after the Bank of England slashed its policy rate and signaled its willingness to go negative in response to the pandemic. The U.K. has been haunted by Japanification, which is typically marked by low inflation, growth and yields. Yields on 30-year gilts are almost at level with comparable JGBs, a compelling piece of the phenomenon that has gripped Britain.

The disparity between hedged returns on gilts and JGBs may widen more if the BOE retains the option to take its benchmark rate below zero. Governor Andrew Bailey warned banks of the challenges negative rates would bring, the Sunday Times reported. Such a move would entrench a rally that has already sent yields on the front end and belly of the U.K. curve into negative territory.

In contrast, two-year Treasury yields have stubbornly stayed around 0.16% in recent months after several Federal Reserve speakers outlined their aversion to negative rates. The BOE meets next on Aug. 6.

NOTE: Ven Ram is a currency and rates strategist for Bloomberg's Markets Live. The observations are his own and not intended as investment advice

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