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Treasury Yields Have Never Been This Negative for Euro InvestorsBy and
Strains build in cross-currency basis swap market at year-end
This year, potential U.S. company repatriation is also at work
There’s never been a worse time to be buying Treasuries if you’re a euro-based investor.
For purchasers in Germany, France and other euro-zone countries who use swaps to protect against currency swings, the yield on 10-year Treasuries fell Friday to around minus 0.64 percent. That’s a record low in data going back to the common currency’s debut in 1999. And it’s a far cry from the 2.35 percent available to those purchasing the note unhedged.
The culprit for the negative rate is largely the swelling cost to convert euros into dollars through what’s known as the cross-currency basis, now at around minus 105 basis points. That’s the widest since 2012.
While funding markets are often strained at year-end, this time has an added twist. The tax plan being debated in the U.S. Congress could spur American companies to bring home some of the trillions of dollars they’re estimated to be holding offshore. And the anticipation of its passage could be why funding markets are feeling squeezed, according to Gennadiy Goldberg at TD Securities.
Here’s a scenario: a European company needs greenbacks, and usually sells dollar-denominated debt to get them. Ordinarily, U.S. firms with offshore cash would be buyers of that debt. But now, they’d rather not lock up their funds if they plan to repatriate cash. So to find demand for their obligations, European issuers would borrow in euros and tap the swaps market to get greenbacks.
The extra demand for these swaps strains the system, and it all adds up to a funding crunch that some strategists say may just get worse.
“As repatriation flows begin to happen, I certainly think that you’ll see overall funding levels become a bit more negative,” Mark Cabana, head of U.S. short-term rates strategy at Bank of America Corp., said in a telephone interview. “You could have these funding strains evident for several quarters.”
The U.S. tax code requires American corporations to pay taxes on overseas earnings, but profits are only taxable when they’re brought back to the parent company. Hundreds of U.S. multinationals get around this by indefinitely reinvesting earnings offshore. Congress’s Joint Committee on Taxation has said the stash totaled $2.6 trillion in 2015 -- up about $300 billion from three years earlier.
Cross-currency basis swaps are often used by corporate treasurers, but also by bond investors like life insurers who want to hedge away currency risk. In the case of European buyers of Treasuries, the transaction breaks down as follows:
To get hold of dollars with which to purchase U.S. debt, they turn to a combination of the London interbank offered rate for dollars (now 1.61 percent), their local Libor (minus 0.39 percent) and the basis (1.05 percent), which added together more than offset the current 10-year yield.
“If someone really needs to obtain dollars and is willing to materially pay up through FX forwards or the cross-currency basis, it has the potential to really move these levels around quite meaningfully,” Cabana said.
Investors in Japan also face dwindling hedged yields, though their Libor rate and the dollar-yen basis aren’t as negative as in Europe. For the Japanese buyer, 10-year Treasuries yield minus 0.06 percent.
Of course, investors have options. They can just choose not to hedge currency risk, buy higher-yielding U.S. bonds or purchase other countries’ sovereign debt.
The latter option looks increasingly attractive to Japanese buyers, Tetsuo Ishihara, U.S. macro strategist in the fixed-income division of Mizuho Securities USA in New York, said in a note Thursday. For instance, 10-year French debt, which yields 0.63 percent, offered almost 1.2 percent on a hedged basis on Thursday since swap costs favor yen-based investors, he wrote.
But for those who need access to the world’s main reserve currency, the strains building in funding markets could prove costly. And the renewed sense of urgency among Congressional Republicans to pass their tax plan before year-end could exacerbate the rush for dollars.
“We would have thought that the year-end issues this year wouldn’t be as bad as they were last year, but the repatriation angle makes it more difficult to predict,” said Goldberg, an interest-rate strategist at TD in New York. “Things could get worse into year-end.”