CreditSights: Corporates Gain Favor Abroad
When the Treasury Department released the latest data on foreign purchases of U.S. securities, covering November of last year, the numbers showed a sharp jump in the demand for U.S. corporate debt to $29.7 billion from $20.9 billion in October. This is the second-highest volume of monthly corporate purchases on record, exceeded only by the $33.4 billion seen in May 2001, and it diverges sharply from our model-based forecast for the month.
The increased demand was very regionally concentrated, being driven largely by the U.K., which purchased $13.6 billion versus just $7.6 billion in October, and the Caribbean region, which purchased $8 billion versus $4.8 billion. Data from the Caribbean region is taken to be largely reflective of hedge fund activity. The data further reveals that the purchases are concentrated in the private sector (97%), with only a minimal amount of volume attributed to foreign official institutions. As we have noted previously, foreign purchases of U.S. corporate debt have proven to be highly sensitive to the volume of fixed-rate corporate bond supply and it is this relationship that makes this latest month's data such an anomaly.
Our measure of fixed-rate supply, combining both the investment-grade and high-yield sectors varied little in November from the preceding months. $57.3 billion of supply in November followed $54.8 billion in October and $53.9 billion in September. When offshore investors last stepped up to the plate to buy this amount of corporate debt, supply had virtually doubled from $47 billion in April 2001 to $90.7 billion in the following month. And when the issuance volumes fell back in June, so did the foreign purchases.
We can be less confident of such a prediction in this instance given the seeming breakdown in this previously reliable relationship. Nor does it appear as though the increase in appetite can be attributable to sizeable spread moves. While it is hard to make a definitive case that heightened purchases of corporates are a result of substitution of these assets for agencies in offshore portfolios, there is no denying that the waning demand for agency paper has been more than a one-month trend. Foreign purchases of agencies had been on a solid growth trajectory since the mid-1990s but 2003 volumes look set to be lower than full-year 2002 (versus substantial increases in the volume of Treasuries and corporates). A comparison between the two halves of 2003 is even more telling. In the first six months of last year, foreign purchases of agencies totaled $108 billion. In the five months to end-November, they equaled just $37.5 billion.
There have certainly been months that saw fewer agency purchases than November did (in September there were actually $3.2 billion of net redemptions) but the travails that have plagued the agency market, initiating changes in regulation and altering investor perceptions of the volatility of these assets, are not behind us yet. The flames surrounding GSE reform are set to burn even brighter in 2004 with the issue of the implied government guarantee that is enjoyed by the agencies directly in the spotlight. The suggestion that in the second half of 2003 investors were executing a sell-agencies/buy-corporates trade is speculative conjecture that remains largely unproven. However, it does tally rather well with the price action into year-end 2003, doesn't it?
