Government bonds are debt securities issued by a government to support its spending and obligations. In some cases, they offer a low-risk investment option for individuals and institutions. Investing in international sovereign debt, as compared to domestic (U.S. Treasury securities), involves a range of considerations regarding yields and risks.

10-year U.S. Treasury notes, also known as T-notes, are low-risk fixed-income investments that pay a set interest rate every six months. Treasury notes are considered a “risk-free” benchmark against which other investments and debt are compared since the U.S. government backs them. The sovereign debt securities of non-U.S. countries are backed by the issuing government’s ability to pay back the bondholders.

International sovereign debt can offer higher yields, especially in emerging markets, but comes with additional risks such as currency risk, credit risk, political and economic risk, and liquidity risk. Currency risk is significant, as fluctuations in exchange rates factor into the returns when converting back to the investor’s home currency. Credit risk varies widely across countries, with some governments having higher default probabilities. Political risk is another factor, where instability or changes in government policies might affect the country’s ability to honor its debt obligations. Additionally, economic risk encompasses concerns like inflation, growth rates, and fiscal policies of the issuing country. Lastly, liquidity risk can be more pronounced compared to U.S. Treasuries, as some international bonds may be harder to sell at a fair price. All these risk factors should be evaluated when considering potential investment in a foreign government’s debt securities.

The Chart below ranks the top ten countries in the world by their Gross Domestic Product (GDP) and displays their corresponding Debt-to-GDP ratios and 10-Year Government Bond’s Yield to Maturity (YTM). GDP is primarily used to measure the strength of a country’s economy. It is derived by aggregating expenditure on fresh consumer goods, new investments, government outlays, and the net value of exports. Debt-to-GDP ratio is an economic metric that compares a country’s government debt to its gross domestic product (GDP).

The U.S. Federal Reserve hiked interest rates a total of 11 times between March 2022 and July 2023 in an attempt to curb inflation. This has resulted in U.S. treasuries yielding their highest rates since before the financial crisis of 2008. As displayed in the chart, the current 10-year treasury yield as of June 20, 2024, is 4.25%. Out of the next 9 largest economies in the world by GDP, only India and Brazil have higher yielding 10-year notes, at 6.98% and 12.13%, respectively. But is it worth it to hunt for yield outside of the relative safety of U.S treasuries and, for example, earn 12% on a Brazilian bond?

Brazil is still considered an emerging economy which leaves investors exposed to a potentially unstable government or political unrest which can cause serious consequences to the Brazilian economy. Even with a comparatively low debt-to-GDP ratio, at 73%, Brazilian debt is rated BB by Standard & Poor’s rating agency, which is considered speculative grade (junk). Additionally, in the last 10 years, the Brazilian currency, the real, has lost more than 50% of its value, so investors are exposed to serious currency risk.

How safe are domestic treasuries considering the elevated debt-to-GDP ratio of the U.S. government?  It is true the U.S. has higher debt relative to its GDP than most other developed nations. However, the dollar has a unique status as the world’s “reserve currency.” This means central banks and financial institutions around the world hold lots of dollars to use for international transactions. They do this because using a single currency rather than having to convert between currencies helps enable international investment and lending. Through the first half of 2024, the dollar has gained strength because the US economy looks healthier than those of many other countries where growth is slower and inflation higher than in the US.

At Eagle Ridge, our goal for the Fixed Income exposure in a portfolio is to achieve capital preservation and moderate levels of income. We believe high-quality bonds are the best hedge against the volatility of common stocks. At this juncture, we are comfortable without international government bond exposure. Our portfolio’s bond allocation remains diversified amongst US Treasuries, Agencies, TIPS, Corporates and Municipals.