CreditSights: The Week In Credit
The Treasury Department released the data covering foreign purchases of U.S. securities in the month of May last week and the numbers reveal that demand remained robust, particularly demand for corporate debt. Net purchases of corporate bonds hit $28.9 billion, a level that has not been seen since May 2001. This brings the total volume of U.S. corporate debt purchased by foreigners in the first five months of 2003 to $117 billion. Any way you look at this number it is surprisingly strong. The monthly average of $23.3 billion has hit a new high and is well in excess of the level seen even during 2001, when U.S. corporate debt was selling like hot cakes to offshore buyers. Even in the context of what has been a heavy period of issuance, foreign demand volume stands out. In May, the demand equated to 66% of the investment grade issuance that took place during that month which compares with an average of 42% for that measure during 2002.
The data is causing us to consider whether there is a secular change afoot in the dynamics of foreign demand or whether we have just witnessed a cyclical peak. May's demand in the corporate sector must be viewed in the context of the uptick in purchases in other types of securities. Foreigners also bought $38.9 billion worth of Treasuries and $32.5 billion of agencies during the month, a significant in crease in demand in both of these sectors, so we cannot characterize the data as revealing a rotation in appetite into the higher-risk corporate sector. The fact that the dollar was getting solidly trounced during the month of May adds a further interesting nuance to the picture. As difficult as it is to make all of these moving parts fit into one coherent picture the most plausible explanation seems to be that of the Baghdad bounce; foreign investors waded into U.S. securities seeking to participate in the post-Iraqi war rally.
So, from the perspective of corporates the cyclical peak theory definitely has some traction. After all, it proved to be the case when foreign purchases last hit this level. After running ahead of forecast in the first five months of 2001, offshore demand dwindled sharply in the second half of the year. But, the fact that purchases as a percentage of investment grade issuance has hit a new range in 2003 has us thinking that there is a secular change also taking place, if not in outright demand for corporate exposure, then at least in the demand for high yield debt. Investment grade issuance in 1H03 is actually down on the same period last year by some $26 billion, but this has been more than offset by a $37 billion increase in high yield issuance when the two periods are compared. And, demand for the high yield asset class has been growing overseas; the Merrill Lynch Euro High Yield Index has doubled in size over the last 12 months. The level of corporate spreads is one of the inputs to our model-based predictions of future offshore demand and as spreads contract they have historically depressed the volume of purchases. It could be however, that in 2003, more lenient investment guidelines among offshore portfolios and an overall grab for yield in a low yield environment is seeing demand migrate down the ratings spectrum rather than contract. However, given that our view of the high yield sector is that it can not sustain the performance or the issuance volumes that we have seen in 1H03, it is quite likely that May's buying spree will represent the high point of monthly foreign purchases for the year.
Analysis by CreditSights, Inc., an independent online credit research platform. Call (212) 340-3888 or visit www.CreditSights.com for more information.