Unintended Consequences – Short Corporate Bank Bonds Modestly Widen

Sometimes it is hard to predict the consequences of your actions. For example, when Thomas Austin of Winchelsea, Australia let loose a couple of dozen imported rabbits on his farm in 1859, no one could foresee they would breed so quickly and cause so much destruction across Australia.

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Unintended consequences also happen in the corporate bond market. Tax law changes can unintentionally lead to wider short-term bank bond spreads! Let’s follow this down the rabbit hole.

In February we saw the corporate market widen by 10 basis points, which we would describe as modest. Short corporate bank paper was impacted slightly more. At one point during the month, 2-year bank paper widened 15 bps. While this was certainly noticeable, in context it was not a large move. The “A” rated corporate index has tightened more than 80 bps since early in 2016.

Thanks to year-end tax reform, corporations who were parking large amounts of cash overseas are starting to bring some of it back. Many corporations, like Apple, Cisco and Google have large overseas cash holdings, some of which is held in corporate bonds. These three large tech companies alone hold over $200 billion in corporate debt, often including high quality, short dated and liquid bank debt. Some money has started to come back, as wider spreads would suggest, but we do not expect a wall of cash or materially wider bank spreads. Plans for cash repatriation are a long-term work in progress and there is no rush to repatriate. The need and timing for cash is very company specific and depends on: their tax situation, the need to repay debt, buyback and dividend policy, as well as the need to fund general corporate purposes.

To be fair, we don’t want to attribute all of the corporate and bank bond widening to tax law changes. We do believe some of the overall widening in the markets should also be attributable to more expensive hedges (as a result of higher short-term interest rates), which can make U.S. corporate bonds less attractive to foreign buyers. Fewer buyers, on the margin, can help push spreads a little wider. 

Unlike rabbits overrunning Australia, this story has a happy ending. Whenever high quality low duration paper widens a few basis points due to temporary technical issues, we become a better buyer. More yield on safe investments is always appreciated, unlike a horde of rabbits.

Sources: Bloomberg, BofAML, The Financial Times