Apple Making America Great Again? For IG Bond Spreads Not So Much

Now that the market is taking a bit of a breather from shoveling USD and its fixed income products onto the bonfire, we can step back and take a look at one of the late 2017 themes that may--or may not--be starting to play out in 2018.

The US tax reform has exited the sausage-making process and gone into effect.  We are starting to get the headlines about the impact: last week it was retailers like Walmart promising bonuses and wage increases, this week, Apple--that bastion of far-right economic conservatism--is pledging to Make America Great Again:

Did anyone check Tim Cook’s tax returns for donations to the Trump campaign? Just askin’.

Yet with all that money comin’ home, a funny thing happened on the way to making America Great Again. The USD has gotten whipped like a lame horse:

So what gives? Aren’t companies like Apple repatriating billions of dollars from overseas? Why isn’t the market pricing in that flow back into USD?

This theory--that cash held offshore was somehow by definition denominated in another currency--is an argument built on a sand foundation. Indeed, today an article on FT Alphaville noted something crazy--Apple manages one of the world’s biggest portfolios of corporate debt from an office in Nevada, but the custody of this massive pile of assets is in Belgium, Germany, or some Cayman holdco. And most of that is in or hedged into USD, even if it is in a metaphorical German bank vault.

The particle physicists that keep track of these things at JP Morgan seem to agree. Earlier this week their research team published some estimates of the stock of offshore profits, how much could be repatriated, and where it is held.  

By their estimates, of the $2.2trn held offshore, only $460 billion of could potentially be repatriated as an FX flow--15.5% of that would be lost to taxes--leaving $400 billion to come back over a number of years. For FX markets that qualifies as a drop in the bucket--especially when dealing with corporate treasuries that have no pressing need to do this trade tomorrow--they can take their time and drip it out in $10mm sell tickets every day for two years.

The bigger change that the Apple move illustrates--and alphaville highlights--is the potential for this “cash” to go back to shareholders. The offshore cash isn’t really cash anyway--more often it is held in high grade corporate debt. More than any potential change in the structural value of USD, these moves by corporate treasurers--combined with higher rates-- might mark a regime change for inflows into IG corporate markets, and a low in high-grade spreads.

Or maybe we’re in 2004….the point is not that this change in flows into corporates is going to blow spreads out to UST+300bps overnight, but the demand for paper to continue spread compression might have dried up.  As FT Alphaville points out, there’s no reason why Apple--or any other company with billions of offshore profits-- needs to fire sale these assets, and there are still investors tripping over themselves to reach for yield in some of the world’s weirdest  and fragile economies.  (insert your own “Trump as EM bond portfolio manager” joke here)  

The bigger piece of the puzzle is indeed the quantity of foreign profits already held in USD--because this is what could come back and get sold into the market or allowed to run off into cash to be paid back to shareholders. JPM highlighted this chart for illustrative purposes--showing the known allocations of a few tech giants which are probably managing their portfolios in a similar way to other corporate treasuries.

These five companies comprise roughly ¼-to-⅓ of the total stock of offshore profits, meaning there could be $600 billion in corporate debt and and equal amount of US treasury and agency bonds that could--if not hit the market--not be available for re-investment at maturity. Sure, these are huge markets as well, but even if you parcel out $600bn in these markets over five years, you’re still talking about a significant amount of supply that will need to find another home.

So what’s the trade? I think this is another reason to flee high-grade credit risk, and while the tax windfall for the federal government will pad the fall for UST and agency borrowing rates, again--it is just another headwind for rates at large.

Sure, if global growth rolls over or if inflation catches fire later this year this type of flow won’t mean much for the direction of rates--the broader point is that the key flow from the US tax reform is in corporates, not FX. The long-term risk-adjusted returns for corporate credit are bad, and the flow outlook just got worse too. Sad!

Shawn
TeamMacroMan2@gmail.com
@EMInflationista