European bonds' glitter obscures risks

September 15, 1992|By David Gillen | David Gillen,Bloomberg Business News

NEW YORK -- European bonds are beckoning now that Germany's Bundesbank has finally put Europe on the road to lower interest rates. U.S. investors had better think before they answer the call, investment managers say.

Dollar-based investors expecting to cash in on Europe's high yields and rising bond prices could see their returns wiped out since German central bankers revived the dollar with an unexpected cut in official rates yesterday, managers said.

"The Bundesbank's move is unabashedly bullish for global interest rates, and for investors in global bonds this presents opportunities and challenges," said Adam Gresham, portfolio analyst at Scudder Stevens & Clark in Boston. "There's no doubt there are attractive yields in Europe, but there are risks on the currency side with the dollar coming off post-World War II lows against the mark."

The Bundesbank cut its discount rate half a percentage point to 8.25 percent and the Lombard rate a quarter point to 9.50 percent in what many analysts said was a quid pro quo for a 7 percent devaluation of the Italian lira.

Germany's rate cut, quickly followed by rate reductions in the Netherlands, Sweden and some other European countries, comes less than a week before France holds a referendum on European union. Many analysts said the Bundesbank's move was designed to bolster support for European union before the Sunday ballot.

For U.S. bond buyers, however, investing in high-paying European bonds is trickier than ever, these managers said. The dollar, battered this year by the large difference between German and U.S. rates, surged yesterday as much as 10 pfennigs from the previous Monday when investors saw German rates were finally coming down. That kind of appreciation will eat into returns for U.S. buyers of European bonds.

Many fund managers hedge against such currency risks by selling dollars at current rates for delivery in the future. Hedging with such "dollar forwards" costs U.S. investors in German bonds about 6 percent a year, the current difference between short-term German and U.S. rates. That means German bonds must return at least 6 percent annually for U.S. investors to earn as much as they would holding ultra-safe U.S. bonds.

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