There are no borders when it comes to the hunt for yield, and foreign investors apparently found what they were looking for in the U.S. last year.
After the Federal Reserve began raising rates for the first time in nearly a decade, foreigners rushed to “buy American” in the U.S. corporate debt market in 2016 at the fastest pace in years. Foreign entities now hold almost 29 percent of U.S. corporate bonds, up from 12 percent in 1990, according to Morgan Stanley.
U.S. interest rates, though still very low, were more attractive than many others around the world, where central banks pushed more than $12.9 trillion in debt into negative-yielding territory by last summer. Corporate America also issued a record mountain of debt last year, in an effort to lock in low interest rates — and debt payments — before more Fed interest rate increases. Foreigners were ready buyers.
The question now is what happens as interest rates rise globally, and the trend stands to reverse. Less debt now trades with a negative yield.
Morgan Stanley bond strategists, in a recent note, point out that as rates rise, the need to buy U.S. debt may not be “as extreme.” There have been some signs of a slowdown already this year they note with the biggest outflow of Japanese investors from U.S. credit since October 2015. Japanese buyers are finding other instruments increasingly attractive, when considering currency hedges.
“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.
The hunt for yield by foreign buyers also helped support a surge in U.S. debt offerings. U.S. corporations sold a record $1.3 trillion in investment-grade debt last year, and are on track for another record this year with $451 billion year to date, according to Informa Global Markets.
Foreign ownership is nothing new, and it has been on the rise since the mid-1990s. Morgan Stanley reports that in 2016, foreign investors held 28.7 percent of the U.S. credit market, up from 26.5 percent the year earlier and 23 percent in 2011. Analysts say the rise in corporate debt holdings also parallels a decline in foreign ownership in the U.S. Treasury market, where the Fed is the largest holder.
Life insurance companies, once the largest holders in the credit market, are now second-biggest holder, with 21.5 percent in 2016, up from 20.7 percent in 2015, according to Morgan Stanley. That group held nearly 50 percent of the corporate bond market in 1990.
Households, including retail investors, fell sharply in 2016 to 6.5 percent from 9.7 percent. Financial institutions’ ownership stake has dropped in the corporate bond market, and is lower by about half from 2008, as banks de-leveraged. They now hold 8.1 percent.