The 'Electronics for Bonds' Trade Explains Why Corporate America's Borrowing Costs Keep Falling

Foreign buying behind tightening investment grade spreads, says BofA.
Photographer: Brent Lewin/Bloomberg

The past year has seen a Chinese currency devaluation, a rate hike by the Federal Reserve, 'Brexit,' and a failed coup.

But after risk premiums on the debt sold by U.S. companies jumped amid the oil price downturn and the market turmoil that characterized the start of 2016, spreads on investment-grade corporate bond have now tightened to right where they were 12 months ago, a Bank of America Merrill Lynch team led by Hans Mikkelsen observes. Investors in bonds sold by U.S. companies with relatively stronger balance sheets might have one big group to thank for the ability of their market to buck a growing laundry list of potential headwinds.

"Aside from a positive macro environment, as equities are setting new record highs, we continue to think foreign buying represents the biggest tailwind for our market," according to the strategists, who have dubbed overseas purchases of U.S. corporate debt the "electronics for bonds" trade. They explain that "We continue to expect that the U.S. effectively will finance the [current account] deficit in 2016 by selling $400-500 billion of corporate bonds to foreign investors" — a figure which happens to closely align with the $500 billion or so trade deficit the U.S. runs in electronic equipment. "Hence the trade is electronics for corporate bonds."


Source: Bank of America

In late 2015, Mikkelsen predicted that an expansion of monetary stimulus by the European Central Bank would ultimately displace some investors from the European corporate debt market — and they'd have no choice but to scurry across the Atlantic to search for their yield.  

Foreign appetite for U.S. corporate debt may be magnified by recent ultra-low returns on benchmark government debt — which have helped bolster stocks and other risk assets — as well as currency fluctuations. Analysts at Citigroup Inc., for instance, point out that Japan, an electronics exporter whose stable of offerings includes Nintendo Co., Toshiba Corp., and Sony Corp. product, has been taking advantage of a stronger yen to import overseas bonds on the cheap(ish). The island nation's purchases of foreign debt surged to a weekly record in the seven days ending July 8, according to Citigroup figures.

Source: Citigroup

In other words, there's still plenty of evidence to support Mikkelsen's call that investment-grade spreads will tighten to 135 basis points before the year is out.