Our US bond strategists anticipate a long-run bull market in the US dollar. This will act as a major headwind for USD-denominated sovereign debt.
The recent performance of sovereign debt relative to US credit has bucked its traditional correlations with the dollar. The beta between sovereign excess returns and the dollar has moved into positive territory. Historically, the correlation does not remain at these levels for long and sovereign debt should underperform as the more typical negative correlation is re-established.
In the long-run, the performance of sovereign debt relative to equivalently-rated and duration-matched US corporate credit tends to track movements in the dollar and bullish sentiment toward the dollar. This is because, when the dollar appreciates, it makes USD-denominated debt more expensive to service from the perspective of a foreign issuer, and therefore causes sovereign debt to underperform domestic alternatives.
Bottom Line: Continue to favor US corporate credit over USD-denominated sovereign government debt.