Higher yields don’t always mean higher returns. Beware the hidden currency risk.
How many investors, returning to bonds after years of neglect, are almost mesmerized by the nominal yields of US Treasuries, now significantly higher than those of European bonds? The answer is clear: many. The reasoning is familiar: “The United States seems like a safe bet, the deepest bond market in the world, and the dollar is the global reserve currency.”
But what if the real risk is not the bond itself, but the currency in which it is denominated? What if it is not the Treasury that erodes returns, but the dollar? This is far from a theoretical concern, as European investors in 2025 discovered when the greenback’s depreciation significantly reduced their returns. The key question now becomes unavoidable: what does holding Treasuries really mean in 2026?
Bonds and currency: the factor many underestimate
When investing in bonds from developed markets, attention cannot stop at nominal yields or yield to maturity. A crucial, often overlooked factor is currency.
For a European investor, the final return depends on two separate components: the bond’s performance and the exchange rate movement between the investment currency and the domestic currency, the euro.
In practical terms, even a credit-risk-free bond can become a mediocre or negative investment if the currency moves against the investor. This is why choosing between euro- and dollar-denominated bonds is not marginal—it is structural. The decision is not only between Bunds or Treasuries, but between two currency zones with fundamentally different dynamics.
Euro or dollar: the classic dilemma
The recurring question is always the same: “Are euro-denominated European bonds better than dollar Treasuries?”
US Treasuries offer higher nominal yields. Yet, investors who bought them in 2025 often experienced exchange rate losses that offset—or even exceeded—the coupon advantage.
In 2025, the dollar weakened significantly against the euro, meaning a Treasury yielding a nominal 4–5% could deliver a real return close to zero, or even negative, for a European investor. The question today is not whether this has happened, but whether it could happen again in 2026.
How Treasury yields translate for foreign investors
To understand the issue, consider a 10-year Treasury yielding 4.5% nominally. A European investor buys it when the EUR/USD rate is 1.05. After one year, the investor collects the coupon, but the exchange rate rises to 1.15.
The resulting currency loss is roughly 9%. Even assuming a stable bond price and a 4.5% coupon, the total return becomes negative.
The lesson is clear: total return is not simply coupon plus price appreciation—it is bond performance plus currency performance. This is why focusing solely on nominal Treasury yields can be misleading.
Where we stand today: a weak dollar at a crossroads
After its sharp decline in 2025, the dollar now sits in a technically delicate zone. It has lost significant ground and is hovering near levels that historically often marked lows. This makes the dollar technically cheaper than a year ago—but not necessarily cheap in absolute terms.
The euro, conversely, is coming off a year of relative strength, having benefited from favorable interest rate differentials. However, currency trends are rarely linear, and past advantages can quickly turn into disadvantages if market dynamics shift.
Key drivers of the euro and dollar
Currency values are influenced by multiple factors: economic growth differentials, real interest rate spreads, monetary and fiscal policies, capital flows, and global sentiment.
In the United States, dynamics are increasingly complex. The Federal Reserve faces political pressure, with Jerome Powell publicly criticized by the administration. Simultaneously, the Fed continues to support the banking system following repo market tensions, while the government intervenes in the mortgage-backed securities market to contain mortgage rates. In financial terms, this constitutes a liquidity surge.
Excess liquidity tends to support demand for financial assets, including Treasuries. Strong demand for Treasuries can also drive dollar demand, particularly if political developments, such as potential tariff adjustments, improve the investment outlook. In that scenario, the dollar could experience a sustained reversal from recent weakness.
Why the euro remains a relative safe haven
For European investors, the euro offers a simple but fundamental advantage: it is the reference currency. This eliminates exchange rate risk entirely.
While European bonds tend to offer lower nominal yields, currency stability represents a form of implicit protection. Furthermore, the European bond market, although less spectacular, is often more predictable. In a climate of macroeconomic and currency uncertainty, predictability can be more valuable than headline yields.
So?
The choice between euro- or dollar-denominated bonds does not have a one-size-fits-all answer. It depends on the macroeconomic backdrop, expectations for real interest rates, the trajectory of the dollar, and investors’ tolerance for currency risk. In 2026, bond investing is no longer linear, and currency considerations may matter as much—or more—than the bonds themselves.
Original article published on Money.it Italy 2026-01-19 08:21:00. Original title: Meglio comprare obbligazioni in Euro o Dollari? Le previsioni
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