We continue to urge caution on foreign bond funds. For much of the past decade, a weaker dollar was the foreign bond markets best friend as appreciating foreign currencies led to strong returns. However, with prospects for continued dollar strength, foreign bond market returns could be restrained.
A second dynamic diminishing the appeal of this sector are low yields overseas. As shown in the adjacent chart, yields on government bonds are meaningfully lower overseas than in the U.S. Low yields mean low return potential, and make the asset class even more at risk of loss due to currency volatility.
Importantly, our caution primarily applies to funds that do not hedge their currency exposure. Many foreign bond funds fully or partially hedge their currency risk.