Foreigners Souring on U.S. High-Grade Credit Leave UBS Unfazed

  • ‘Too early’ to make a call that net outflows will continue
  • Europe, Japan investors may continue selling on hawkish Fed

Foreign investors may be bailing on investment-grade U.S. corporate bonds, but that’s not unsettling UBS Group AG strategists.

For now, U.S. high-grade credit remains a buy, says London-based Kathleen Middlemiss, global head of credit strategy at UBS. That’s after her team’s analysis showed European and Japanese investors were behind the first quarterly net outflows of institutional and retail funds from American investment-grade corporate debt in more than a year last quarter.

Source: UBS

The shift by Japanese and European institutions reflected some easing in dovish monetary-policy stances in their home economies, and it’s “too early” to make a call on whether the diminished appetite will continue, according to UBS. European Central Bank President Mario Draghi indicated on Thursday that he’s not prepared to taper stimulus yet, while the Bank of Japan meets to set policy next week.

“We are sticking with our preference for U.S. investment grade on a total return basis,” said Middlemiss in an interview. “Fund flows are clearly something we watch, but it is lagged.”

U.S. high grade names are “still offering yields” within an expensive space, according to UBS. The team’s strategists also like European high yield and U.S. leveraged loans as they are higher in quality and shorter in duration, “with substantial cash buffers waiting to be deployed.”

At the same time, UBS indicated there are key dynamics to watch for future fund flows:

  • If the Fed turns out to be more hawkish than expected, it could flatten the Treasury yield curve and keep foreign exchange-hedging costs elevated, reducing the incentive for European and Japanese institutional investors to return
  • Any move by the ECB and BOJ to pare back stimulus could result in higher yields in Japanese and euro debt, making them more attractive to domestic investors
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