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The chart shows it best.


A fast rising dollar is good for currency traders.  But it isn’t good for everyone (like bond holders).

Let me tell you why.

Some of the highest bond yields are found outside of the United States. International bonds issued by foreign governments and corporations often pay higher yields than domestic bonds.

Just look at the Oppenheimer International Bond Fund (OIBYX).  It’s one of the top performers over the last five years.  The fund’s returned almost 8% a year at a time when the stock market has been falling.

Right now the fund’s yielding a juicy 4%.  And that’s a great return, but it’s at risk.

Recently the US Dollar has been moving higher.  And that cuts into international bond returns.

How?

If you have an international bond fund paying 4%, you receive $4 in foreign currency for every $100 US Dollars invested.  But the return assumes currency rates stay stable.

If the US Dollar goes up in value by say 10% (which it’s done in just the last few months), it now takes 10% more foreign currency to convert into a single US Dollar.  So your $4.00 yield after it’s converted to US Dollars is more like $3.60.

Your yield has dropped by $0.40.  I know it doesn’t seem like much, but most international mutual funds own millions and tens of millions of dollars of bonds.  The difference in yield is huge!

So as the US Dollar keeps climbing, yields from international bonds are actually falling.

I can see the fear in many investors' eyes… should you sell every international bond you own?  No.  It’s too late for that anyway.  The market’s already had a big move.  Just be aware of what’s going on.

Could it get worse?

Of course it could.  Bigger problems out of Europe could continue pushing the US Dollar higher… and driving down the value of international bonds. But that might not be the worst thing.

Think like a contrarian…

Act like a salmon swimming upstream.  Right now the US Dollar is climbing.  It won’t always be that way.  Sometime in the future… probably in a few months… the global fear will subside.  Investors will start getting greedy again and the US Dollar will once again start sliding lower.

The horrible impact a climbing US Dollar has on international bond funds will reverse.

A falling US Dollar will start amplifying international bond returns. When the US Dollar reverses course and starts falling, look to put some money in international bond funds.  When those yields are brought back to the US, they will buy more dollars and amplify returns.

If you have a diversified portfolio that includes bonds, keep your eyes peeled.  A number of outside influences could significantly impact your returns… for the better or the worse.  While now might not be a time to exit international bonds, the time to buy is quickly approaching.

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