While overseas demand for US corporate bonds fell for the first time in four months in June on a weaker dollar, analysts see foreign investors returning to a market that still offers higher yields, even on a hedged basis.
Foreigners turned into net sellers of corporate bonds, which include asset-backed securities in June when they sold US$16.6bn of such securities, US Treasury data released on Monday shows.
That compares to May when they bought US$13.6bn in corporate paper.
While overseas accounts pared their US corporate holdings in June, they bought US$28.9bn in US Treasuries, US$38bn in agencies and mortgage-backed securities and US$28.5bn in stocks.
In May, foreign investors sold US$36.7bn in Treasuries but purchased US$2.4bn in agencies and mortgage-backed securities and US$79.7bn in equities.
The drop in foreign purchases coincided with a downturn in the dollar, stoked by anxiety that the Covid-19 pandemic will remain a more severe drag on the US economy than what traders and investors had previously thought.
It also comes on the back of heavy issuance this year in the investment-grade primary market, where volumes have already hit yearly records of US$1.372trn in 2020, according to IFR data.
The Fed's slashing policy rates to near zero and renewed expansion of its balance sheet in a bid to buffer the economy from the virus has also eroded the value of the greenback.
"The dollar is trading off here. You have seen less foreign demand for US credits. It bears watching," said Greg Peters, head of multi-sector and strategy at PGIM Fixed Income.
On Tuesday, the dollar index, which gauges the greenback against a basket of currencies, declined to 92.127, the lowest level since May 2018, according to Refinitiv data.
It hit a three-year high back in March at 102.992 prompted by safe-haven demand for the dollar when Europe and China were the hot spots for the Covid-19 infection.
However, analysts and investors reckon the foreign pullback in US corporate bonds is limited as they offer higher yields than their counterparts in most other G10 economies.
Since late July, Wall Street dealers have been taking down their high-grade bond inventory for sale to overseas investors rather than to their foreign affiliates, implying renewed overseas purchases for corporate paper, Bank of America analysts wrote in a research note on Monday, citing Trace data.
Together with interest rates near record lows in most developed economies, a weaker dollar has lowered the hedging cost for European investors, according to Robert Robis, chief fixed income strategist at BCA Research.
For European investors, US high-grade bonds with three-month forward dollar hedges would have on average earned a yield of 1.13% at the end of July. This compared with a 0.64% yield on comparable European IG debt.
"For corporate bonds, both US high-yield and investment-grade offer more attractive yields, in both dollars and euros, relative to euro area equivalents," Robis wrote in a July 28 research note.
"Stay overweight US corporates versus the euro area in dollar-hedged and euro-hedged portfolios."
GRPAHIC: Foreign purchases of US corporate bonds https://tmsnrt.rs/2NYwkDF