The impact of "repatriation," or bringing previously trapped "offshore" cash and assets back into the U.S., continues to be one of the biggest guessing games in the money markets. BlackRock is one of the latest to address the topic, in a recent paper entitled, "When corporate cash goes free: Repatriation and the impacts of tax reform on the short-term markets." They explain, "The seatbelt sign has been turned off, and we believe corporations are starting to assess how to address new rules for overseas cash in the just-released U.S. tax code reform. We offer some of our early thinking on what the repatriation rules of the tax overhaul may mean for short-term investors, markets and the economy." (See also J.P. Morgan Securities' new comprehensive update, "Repatriation manifestation.")
BlackRock writes, "New tax legislation has been enacted and became effective January 1, 2018. Now what? The U.S. government has stated that the tax overhaul is meant to, in part, make the U.S. more competitive from a corporate standpoint and in line with other countries, support economic growth and reduce complexity. The recently approved tax package included some significant changes for corporations. They include: A reduction in the corporate tax rate from 35% to 21%. A one-time deemed repatriation rate on tax-deferred foreign earnings: 15.5% for liquid assets, and 8% for illiquid assets. An exemption from U.S. taxation for dividends from foreign subsidiaries paid to U.S. parent companies."
They tell us, "What are corporations expected to do with the remainder of their accumulated earnings after taxes are paid? Once U.S. taxes are paid, corporations will have more flexibility in regard to this previously 'trapped' cash if repatriated .... The redeployment of this money could have implications for the cash and short-term markets. Just how big are these accumulated untaxed earnings? What are they presently invested in? General market consensus is that the amount of accumulated untaxed earnings sitting offshore for U.S. corporations is in excess of $2 trillion. Much of it is held by corporations in the technology and pharmaceutical industries, primarily denominated in U.S. dollars."
The paper continues, "Looking at the top 10 largest corporations by offshore earnings, most of the liquid earnings are estimated to be held in corporate bonds and short-term U.S. Treasury bonds. The balance is mostly in cash instruments.... It is difficult to predict when we might see significant cash movement as companies have eight years to pay taxes on untaxed earnings with Internal Revenue Service guidance on minimum annual payment requirements still forthcoming.... Our view is that corporations are tackling this issue at their own pace. We do not expect to see a mass wave of repatriated cash at a single time, rather, we expect this scenario to play out in a measured way throughout 2018 and beyond."
It states, "In our view, repatriation should herald moderately higher short-term funding costs for non-U.S. banks, particularly those that rely on short-term wholesale funding like time deposits, certificates of deposit (CDs) and repurchase agreements (repo) to engage in arbitrage activity. Some of these non-U.S. banks could feel pressured as corporations may directly or indirectly (via money market funds, for instance) liquidate assets invested in various bank obligations like CDs to pay repatriation taxes and bring formerly 'trapped cash' back on shore."
BlackRock explains, "These banks may thus have fewer reserves (or less cash) at their disposal. The result is banks will need to pay up for reserves, or shrink their balance sheets. U.S. banks, on the other hand, are mostly funded by retail deposits and should be less affected, in our view. All told, we see a possibility of modestly higher funding costs for some non-domestic banks over the next 24 months. Credit spreads (such as the LIBOR/Overnight Index Swap (OIS) spread) could also widen as corporations seek to reduce cash, money market fund, and other short-term marketable securities holdings leading to supply/demand imbalances."
Their piece continues, "In our view, fears that there will be widespread and sustained selling of short-duration corporate bonds as a result of tax reform are vastly overstated. With respect to the taxes owed, the majority of corporations do not need to physically sell securities to meet their tax bill.... Given the short-term nature of their holdings, companies can simply let their bonds mature and pay their tax bill over eight years rather than become forced sellers. That being said, while selling activity may be modest, the removal of a large core holder of front-end credit means that further purchases by these corporations going forward is likely to be substantially lower as well.... As a counterbalance to the demand picture, `the supply outlook for investment grade corporates is also likely to be heavily impacted by tax reform. In our view, barring M&A-related fundings, front-end supply will likely drop in 2018 as cash on hand is deployed to term out upcoming maturities."
It also says, "As noted, repatriation could result in modest pressure on bank funding levels which is expected to translate into marginally higher yields for investors in bank obligations such as time deposits and CDs. Repatriation is just one component of tax reform that could influence the short-term markets in the months ahead. For example, the anticipated boost to the economy provided by the fiscal stimulus described earlier should further support the gradual removal of monetary accommodation in the form of at least three rate hikes in 2018, assuming financial conditions remain accommodative."
BlackRock continues, "At the same time, the normalization of the Federal Reserve's balance sheet, combined with an anticipated increase in the U.S. Treasury's cash balance, are anticipated to lead to a significant increase in the net issuance of Treasury bills (T-bills) in the months ahead.... In turn, this additional supply could exacerbate the impacts of tax repatriation at the front end of the market."
They add, "Given tighter funding conditions from an anticipated reduction in reserves driven by this repatriation and Federal Reserve balance sheet normalization, along with the expected increase in the supply of T-bills, we could also see a widening of spreads between T-bills and OIS. This could also result in incremental upward pressure on overnight government repo rates. While U.S. government money market funds could see inflows in the event that formerly 'trapped' cash is temporarily housed in them, we believe supply should be sufficient to accommodate any such flows.... Additionally, we believe short-duration strategies will remain a key investment strategy for corporate treasurers beyond the repatriation period as they continue to seek attractive sources of income across their tiered cash holdings if those offshore assets are brought onshore."
Finally, BlackRock comments, "[W]e expect the FOMC to continue on its path of interest rate and balance sheet normalization. As such, we expect yields to rise gradually, benefiting cash investors who seek liquidity and capital preservation in their shorter-term fixed income strategies. With the flatter yield curve since the fourth quarter of 2017, these strategies now offer an increasingly attractive risk adjusted income profile for investors. In short, cash investors have benefited from rising rates in recent months, and tax reform could provide additional opportunities for more attractive yields in cash and short-duration vehicles."
