Earlier this week, Bloomberg wrote an article titled "Corporate America Goes on Debt Diet After $3 Trillion Binge" in which the author argued that due to creeping concerns about rising leverage, US corporations have hit the brakes on debt issuance, citing only three examples to make its case: the massively overleveraged AT&T, Kraft Heinz and GE which indeed disclosed plans to raise liquidity in order to trim their debt.
However, a problem with this argument is that it was incorrect: as the following chart of debt issues in just the last week of February shows, the US bond market is anything but fasting; in fact as a result of soaring investor demand for yield, one can argue that most companies are more than eager to add to their incremental leverage even if it means pain down the road when/if rates once again resume their trek higher.
However, there was one aspect in which the Bloomberg article was spot on, even if it had nothing to do with the underlying premise presented by Bloomberg.
As we first observed last April, 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 (which we now know will end before the end of 2019), or debt being repaid with existing cash, is just another form of quantitative tightening as liquidity is simply soaked out of the market.
Now, over a year after the passage of Trump's tax reform with some $2.6 trillion in offshore cash having been repatriated, 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 in all of 2018... or in the first two months of 2019.
The topic of how cash repatriation impacted bond issuance by the 10 largest US multinationals, was covered in a recent issue of Goldman's weekly "Credit Trader" report, which discussed four key takeaways on repatriation, now that four quarters of reporting have passed since tax reform became effective. It found the following:
- First, the 10 largest cash-rich multinationals were net sellers of $80 billion of corporate bonds in 2018. This amount represents a 25% decline relative to YE2017 levels, which is slightly higher than the 18% decline in the overall investment portfolio.
- Second, and rather amazingly, on the supply side no debt has been issued from this group since late 2017. While debt pay-down has not been regularly cited as an explicit priority for multinationals’ excess liquidity, bondholders have still benefited indirectly from a favorable supply technical: none of these 10 companies have issued debt since late 2017. For context, this group of issuers averaged roughly $80 billion in annual supply from 2015-2017, representing roughly 9.5% of annual IG non-financial issuance.
- Third, as multinationals were selling corporate bond holdings, alternative net sources of demand emerged. EPFR fund flow data suggests the bid for short-dated IG bond funds has remained robust following the passage of tax reform. Since late March 2018, IG short-term funds have recorded over $51 billion of cumulative net inflows compared with a meager $544 million of outflows for long-term funds over the same time frame.
- Fourth, the technical pressure on the front end ultimately proved to be transitory. Concerns related to repatriation and the BEAT (Base Erosion and Anti Abuse Tax) fueled a notable flattening in the front end of IG spread curves from November 2017 through February 2018, which the market viewed as an opportunity to add risk in the front end. While the path has been uneven, front-end IG spread curves proceeded to steepen throughout 2018 and are now hovering around 79bp.
Of the above, the most fascinating observation is the second one: it shows that whereas prior to tax reform, the 10 largest holders of (formerly) overseas cash have completely stopped issuing debt as a result of repatriating hundreds of billions in overseas cash. This has had a substantial impact not only on bond market liquidity and supply/demand dynamics, but on the private sector equivalent of what is effectively quantitative easing
The chart above confirms that while the Fed may have been be withdrawing modest amounts of liquidity from the capital markets so far - roughly at a $36 billion a monthly runrate...
... and will likely soon halt its balance sheet runoff entirely due to complaints from "market participants" in the coming months, Trump's tax reform has had a just as pronounced impact on both private sector liquidity, where bond issuance has collapsed by US multinations, as well as dollar funding markets, and suggests that unless something materially changes in terms of corporate liquidity preferences, financial conditions will remain rather tight once the current period of market euphoria ends.