So one of the themes we’ve explored here and elsewhere recently is the extent to which the move into NIRP across Europe and in Japan has herded investors into USD credit thus putting a bid under Treasurys.
However, as the dollar funding crunch has accelerated, hedging that exposure has nearly eliminated the spread. Deutsche Bank spelled this dynamic out earlier this week:
(Charts: Deutsche Bank)
One of the obvious questions that emerges from this is to what extent is corporate bond buying by the ECB (and now by the BoE) driving investors into US corporate credit? That is, if the yield pickup in Treasurys is eaten up by hedging costs, is that driving a push into IG USD credit? Well the answer, apparently, is “yes.”
Bloomberg is out today with a good piece on this topic. Here’s a quote:
“The foreign hunt for yield in U.S. markets is stepping up as central banks in Europe increasingly crowd out investors from their domestic credit markets.”
“Higher policy rates in the U.S. have reeled in heavy private-sector foreign flows into U.S. corporate bonds this year. And this trend is poised to intensify as valuations in European credit markets become more stretched, while declining returns from currency-hedged investments in Treasuries push portfolio managers into the higher-yielding U.S. corporate credit market, say analysts.”
We’re not sure if it’s by accident or not, but that analysis is spot-on. We’ve always characterized this as an ebb and flow of global liquidity. Money goes where the yield is. It was in US govies and now it’s migrating to US corporates as the cost of hedging dollar exposure rises. That’s not something that you can write off as “esoteric.” It has real implications for IG USD credit. Bloomberg quotes a Wells Fargo note that elaborates on this dynamic. We of course have the note, and it’s good. Here are the notable excerpts:
“According to the Securities Industry and Financial Markets Association (SIFMA), the corporate credit market has grown 54% since 2008, to a combined market size of $8.7 trillion. Putting this in context, the corporate market has grown faster than any other major fixed income market but Treasuries since 2008 (+54% for corporates versus +132% for Treasuries) and, in the not too distant future, it is on track to displace mortgage related debt as the second largest market for the first time since 1990. Alongside this rapid expansion of the corporate market, the investor base has also changed. While corporates were traditionally dominated by U.S. institutional buyers (insurance and pensions), since 2008 two new buyer bases have grown in stature.”
“Since 2014, following the Taper Tantrum, which established the Fed on a hawkish course relative to most other central banks, the foreign buyer has emerged as the new force to be reckoned with in the corporate market and now owns, by our estimates, 40% of the U.S. corporate market.”
(Chart: Wells Fargo)
And here’s one more visual:
(Chart: Wells Fargo)
Of course the interesting thing about this is that US corporates are increasingly resorting to reverse Yankee issuance to take advantage of low rates abroad:
(Chart: CreditMarketsDaily)
But you have to swap those euros back to dollars, and that’s becoming more expensive.
Frankly, the whole thing is really interesting to watch. Previously, observing flows was a kind of boring but necessary exercise. Now, we’re getting to see how money moves in a globalized, interconnected system that’s dictated by central bank policy. It’s like a trial run for what we’re going to have to come to terms with in the years ahead.
Anyway, this is probably bullish for USD IG spreads and eventually for HY spreads as well. As Bloomberg concludes, “U.S. policy makers, investors and market structure will need to adapt to a new world where foreign investors exert a powerful influence in the world's largest credit market.”
Next up, the boss lady herself. Stay tuned.