U.S. companies are finding that the flow from the foreign-money spigot is slowing.
Foreigners showed signs of being net sellers of U.S. investment-grade corporate debt this week, according to Bank of America data. Any selling pressure comes after international investors bought just $38 billion of U.S. investment-grade corporate debt in the fourth quarter, according to UBS Group AG, the least since the beginning of 2016, when the corporate bond market was in a freefall.
Overseas money managers are a key pillar for the market, having bought more than $1.4 trillion of the securities since 2013, UBS said. With the dollar extending losses after plunging last year and hedging costs near decade-highs by one measure, overseas investors have fewer reasons to buy fewer U.S. company notes. The securities are on track for their worst first quarter since 1994. The weakness could translate to even higher borrowing costs for companies than they’ve already experienced in the last three months.
“This problem is here to stay for the remainder of the year,” said Nathaniel Rosenbaum, credit strategist at Wells Fargo, in reference to a falling dollar, rising hedging costs and declining foreign demand.
Overseas demand is a key question for U.S. fixed-income markets broadly. The Treasury, for example, is ramping up debt sales in response to a swelling federal deficit, just as foreign central banks’ appetite may be fading.
A host of other factors have hurt U.S. corporate bonds, which according to Bloomberg Barclays index data have lost 3.3% this year through Wednesday, a bigger loss than the 2.1% decline in U.S. Treasuries. The Federal Reserve hiked interest rates on Wednesday and said it was planning steeper increases in 2019 and 2020. Rising rates make fixed income investments less attractive to money managers and lift corporate borrowing costs.
New tax laws are giving cash-rich U.S. companies less reason to buy corporate bonds. And a growing risk of trade wars could translate to weaker company profits.
“The negative returns are a signal to investors that maybe this is not such a great place to be,” said Kathleen Gaffney, money manager at Eaton Vance, which managed $432.2 billion as of Dec. 31.
For many foreign investors, rising hedging costs are eating into or erasing the extra yield to be earned from a U.S. corporate bond. European investors must sacrifice around 2.7 percentage points in annual yield to hedge using rolling three-month forwards for a year when buying in U.S. dollars and hedging back to euros, data compiled by Bloomberg show. The Japanese have to forfeit about 2.4 percentage points when hedging back to yen, around the highest level since 2008.
For a European investor, buying U.S. investment-grade corporate debt and hedging it back to euros results in yields that are around 0.2 percentage point lower than 30-year German bunds on average now, according to UBS. That’s a big shift from a year ago, when hedged U.S. company notes yielded around 0.44 percentage point more than bunds. As the Fed keeps hiking rates, hedging is likely to get even more expensive.