Capital Markets

Foreigners Feasting on U.S. Corporate Bonds

Pace set to make 2005 the biggest ever for foreign purchases of U.S. corporate debt.
Stephen TaubNovember 17, 2005

Want to know why medium-term and long-term interest rates haven’t risen as much as short-term rates? One reason is because foreigners have been feasting on American paper, most of which still throws off higher yields than comparable maturities overseas.

According to the latest data from the Treasury Department, total net foreign purchases of domestic securities were $1 trillion for the 12 months ended in September, up more than 17 percent from the comparable period a year ago.

One of the biggest beneficiaries has been corporate bonds. Net purchases from foreigners were $364 billion in the 12 months ended in September, way up from $292 billion a year ago. In September alone, net foreign purchases of corporate bonds were $51 billion, up from $40.2 billion in August and far exceeding July’s figure of $24.7 billion. It was also just shy of June’s record $54 billion.

Bond purchases are on pace to make 2005 the biggest ever for foreign purchases of U.S. corporate debt, according to The Wall Street Journal. The paper points out that this increased appetite among foreign investors for U.S. debt comes at a time when most bond pundits were lukewarm on the asset class in general.

Indeed, corporations haven’t exactly been making their paper appealing to investors. The Journal points out that the average spread on corporate bonds — or the amount of interest companies pay over comparable Treasury securities — is well below one percentage point, which is close to the lowest levels in history. “This is probably the peak of the credit cycle and it’s starting to work against you going forward,” Greg Peters, chief U.S. credit strategist at Morgan Stanley, told the paper.

Indeed, global credit quality is slowly beginning to deteriorate. Moody’s Investors Service has already reported that the global speculative-grade corporate default rate climbed to 2 percent in the third quarter from 1.8 percent in the second quarter. “The pendulum is set to swing toward higher default rates, but in a manner that’s consistent with where we are in the credit cycle,” David T. Hamilton, Moody’s director of corporate default research, said earlier this year. “There are no obvious signs of a sharp deterioration in credit quality coming in the next year.”

Hamilton’s assessment is consistent with a Moody’s report released this summer in which analysts warned that North American credit quality may see a slight deterioration in the next couple of quarters, referring to both investment-grade and speculative-grade debt.