Foreign investors apparently found what they were looking for in the U.S. last year as there are no borders when it comes to the hunt for yield.
Foreigners rushed to “buy American” in the U.S. corporate debt market in 2016 at the fastest pace in years after the Federal Reserve began raising rates for the first time in nearly a decade. According to Morgan Stanley, up from 12 percent in 1990, foreign entities now hold almost 29 percent of U.S. corporate bonds.
Compared to central banks all around the world which had pushed more than $12.9 trillion in debt into negative-yielding territory by last summer, the U.S. interest rates, though still very low, were more attractive than many others around the world. In an effort to lock in low interest rates — and debt payments, before more Fed interest rate increases, corporate America also issued a record mountain of debt last year. Foreigners were ready buyers.
The question now, as the trend stands to reverse, is what happens as interest rates rise globally. Less debt now trades with a negative yield.
As rates rise, the need to buy U.S. debt may not be “as extreme,” pointed out Morgan Stanley bond strategists, in a recent note. They note that with the biggest outflow of Japanese investors from U.S. credit since October 2015, there have been some signs of a slowdown already this year. when considering currency hedges, other instruments are being found to be increasingly attractive for Japanese buyers.
“The big risk is that when the cycle turns, global ‘higher-quality’ buyers may realize they have more ‘credit risk’ in portfolios than they appreciated, and these flows temporarily turn the other way,” the strategists note. They say low volatility may be masking liquidity risks.
“Flows from Taiwan have remained positive, but anecdotally, an increase in Formosa and local issuance in Taiwan has diverted flows away from U.S. credit into the domestic market. In addition, European investors also started the year as net sellers of U.S. credit,” the Morgan Stanley authors wrote.
A surge in U.S. debt offerings has also been helped to be supported by the hunt for yield by foreign buyers. According to Informa Global Markets, U.S. corporations are on track for another record this year with $451 billion year to date, and they had already sold a record $1.3 trillion in investment-grade debt last year.
Foreign ownership has been on the rise since the mid-1990s and is nothing new. Up from 26.5 percent the year earlier and 23 percent in 2011, in 2016, foreign investors held 28.7 percent of the U.S. credit market, Morgan Stanley reports. A decline in foreign ownership in the U.S. Treasury market, where the Fed is the largest holder is also paralleled by the rise in corporate debt holdings, analysts say.
According to Morgan Stanley, up from 20.7 percent in 2015, and with 21.5 percent in 2016, life insurance companies, once the largest holders in the credit market, are now second-biggest holder. In 1990, nearly 50 percent of the corporate bond market was held by that group.
From 9.7 percent, households, including retail investors, fell sharply in 2016 to 6.5 percent. And as banks de-leveraged, financial institutions’ ownership stake is lower by about half from 2008, and has dropped in the corporate bond market. They now hold 8.1 percent.
(Adapted from CNBC)