Repatriated Cash Could Present Challenges for Rates

By Ted Howard and Antony Michels

Much of companies’ offshore cash is tied up in US Treasuries; will repatriation flood the market with even more government debt? 

Many companies cheered the new tax rules President Trump signed into law at the end of December. Not only will US MNCs have a lower tax rate going forward, they also get a break on bringing back cash that they kept overseas to avoid paying taxes. But in doing so, says Credit Suisse, they could be creating an “echo taper.” This means that selling the assets to bring home cash could create a glut of US debt in the market. That’s because a lot of that trapped cash is dollars and US Treasuries.

“[O]ffshore cash balances are in US dollars already and are invested mostly in one to five-year US Treasuries and term debt issued by banks,” writes Zoltan Pozsar, director in the global economics and strategy research group at Credit Suisse, who also suggests the repatriation will have little impact on the dollar.

Companies will be able to bring back their overseas cash and be taxed at a rate of 15.5% vs. the previous 35%; it’s even lower, 8%, for so called illiquid assets. Companies have anywhere from $2.6-$3.1 trillion stashed overseas.

At the same time, the US Federal Reserve is forging ahead with plans to reduce its sizable balance sheet filled with Treasury securities amassed over the last decade through its quantitative easing programs (QE). The Fed’s balance sheet increased from $147 billion in 2008 to its current size of $4.4 trillion due to these exercises. According to the latest Fed minutes, the pace of the balance sheet unwinding program has been increased from $10 billion per month to $20 billion per month ($12 billion in UST and $8 billion in US MBS). The Fed then plans to increase this roll-off by $10 billion in the next quarter and each quarter thereafter until it reaches a monthly pace of $50 billion.

With corporations planning to unwind their own UST holdings, and, consequently, no longer buying Treasuries, “yields, swaps spreads and banks’ term funding costs could see upward pressure,” Mr. Pozsar writes.

“In a year where Treasury supply will increase significantly, that’s bad enough,” Mr. Pozsar writes. “But things can get worse: if corporate treasurers add to that supply by selling their roughly $300 billion hoard of US Treasury notes, rates could move big. In fact, we believe this corporate ‘echo-taper’ could be worse than the Fed’s taper.” This is because it is known that the US Treasury will resort to reissuing Treasuries “the Fed no longer buys as bills, not notes, and so the Fed’s taper won’t add a lot of duration back into the bond market. That’s not the case with the echo-taper.”

Mr. Pozsar offers an example of how the market could react by citing China’s sales of bonds from time to time from its vast US Treasury portfolio. “The echo-taper reminds us of China’s occasional sale of its Treasury holdings when [China’s State Administration of Foreign Exchange] defends the yuan,” he writes. “There is always an element of surprise to these sales that leaves a typical trail: higher yields and wider swap spreads as dealers deal with ‘indigestion.’ If the pace of the echo-taper is surprisingly fast, flows on the back of repatriation may well feel like SAFE dumping bonds.”

How much cash and when?

The pace of repatriation will depend on what companies plan to do with the cash. Mr. Pozsar says M&A will quicken that pace. So far Apple is the largest company to detail its repatriation plans, announcing it would bring back a sizable chunk of its reported $252 billion of overseas cash and pay taxes of $38 billion. It has also reportedly said it will cut back on its bond purchases ahead of bringing the cash home.

Lance Pan, director of investment research and strategy at Capital Advisors, echoes this view. “The people that we talk to, the corporates that we talk to, almost no one actually said, ‘Yes, we’re going to bring this cash back because of the tax reform,’ ” Mr. Pan says. “It doesn’t mean they won’t bring the cash back. They only bring the cash back when there’s a reason to use that cash.”

Mr. Pan adds that cost pressure is also “not a reason to bring back dollars.” In fact companies may continue to issue debt rather bring the cash back. Rates remain low, Mr. Pan notes, and the corporate debt issuance market is active. Corporates, he says, are thinking, “when we need capital, we can get it,” reasoning that there’s “still very cheap funding from this market” to be had. Therefore, capital expenditures are not constrained by access to cash. It could mean less demand for liquidity products, however, Mr. Pan says. Nonetheless, there could be shareholder pressure to bring back cash or raise it with debt. “Shareholders are going to get wind of that and pressure management for buybacks and dividends,” he said.