"It's Frozen": The Dramatic Impact Of Tax Reform On The Bond Market In One Chart

Even before Trump's tax reform passed, there were those who suggested that the practical consequences of the tax repatriation holiday on the financial market would be the equivalent of a mini Quantitative Tightening (QT), as it would result in a collapse in bond issuance - and thus liquidity injections - by multinational companies who would hence have full access to their offshore cash, which they could spend as they see fit with no limitations, and would no longer need to tap domestic markets to fund dividends, buybacks, and capex as Apple did for years.

As a further reminder, all QE really is, is the creation and injection of liquidity in capital markets through the issuance of debt; traditionally the debt has been public as it was monetized by central banks in the context of partially locked up private capital market, however issuance of private debt satisfies the liquidity injecting criteria just as well.

Which also means that inverting the process, whether in the form of maturing Treasury debt as part of the Fed's current tightening cycle, or debt being repaid with existing cash, is just another form of quantitative tightening as liquidity is simply soaked out of the market.

Now, nearly 6 months after the passage of Trump's tax reform we have documented proof how correct those who predicted QT in the bond market would be, because as discussed below, corporate bond issuance for cash-rich companies, those that until recently held hundreds of billions in cash in offshore acounts, has effectively frozen with not a single bond issued so far in 2018.

First, here is Goldman with its background on the collapse of corporate supply as a result of deemed repatriation.

The tax reform legislation (passed in late 2017) included a “deemed repatriation” provision which taxed (over eight years) the overseas cash and any previous overseas earnings of US companies. For context, of the companies with large overseas cash holdings, the top eight held $750 billion by year-end 2017. Exhibit 2 details the size and breakdown (by major investment type) of these companies’ investment portfolios. With a total of $328 billion invested in short-dated IG corporate bonds, cash-rich companies own roughly 13% of the total $2.6 trillion universe of index-eligible investment grade bonds with maturities shorter than 5 years.

Recent commentary from companies in the Tech and Pharma sectors (those with the most overseas cash) has referenced potential changes to capital management strategies post reform, ranging from more M&A, higher capex investments, to increased share buybacks/dividends. The pressure on short-dated spreads in the first quarter and the subsequent spillover to commercial paper and the interbank lending market clearly suggest market participants were bracing for a substantial unwind of short-dated IG corporate bond portfolios, to pay for these initiatives. Whether these concerns were justified or not will likely be confirmed by the upcoming earnings calls.

And here is the punchline: supply among "cash-rich" companies has evaporated.

On the supply side and as shown by Exhibit 3, cash-rich companies have historically been active issuers in the USD IG debt markets, averaging nearly $80 billion in annual issuance from 2015-2017 (or roughly 6% of total IG issuance in each year). So far in 2018, however, none of these companies have issued debt. The prospect of reduced appetite from corporate treasurers therefore appears to be at least partially offset by  declining primary market supply.

And visually:

The chart above confirms that while the Fed may be withdrawing only modest amounts of liquidity from the capital market so far, Trump's tax reform has had a far more pronounced impact on both private sector liquidity, as well as dollar funding markets, which incidentally also explains why the Libor-OIS spread has so far failed to tighten nearly 1 month after the end of the massive T-Bill supply onslaught which so many said was the catalyst for the blowout in L-OIS, and suggests that unless something materially changes in terms of corporate liquidity preferences, financial conditions will remain especially tight.