J.P. Morgan Securities' latest "Short-Term Fixed Income" weekly includes a "Non-financial CP update," which discusses a rebound in non-financial commercial paper. They write, "Since the beginning of the year, total US commercial paper outstandings have increased by $74bn, with the vast majority of the increase coming from non-financial companies.... Somewhat surprisingly, this year's growth in non-financial CP followed a year where we saw large reductions in corporate CP outstandings." We excerpt from their comments, and also quote from Federated's latest monthly commentary, below.
The Non-financial CP update explains, "Coming into 2019, we had anticipated the downward pressure on corporate balances would continue as corporations with offshore cash would likely continue to rely on it as a source of liquidity rather than borrow in the CP market. M&A was also expected to slow. Ratings downgrade pressure as a result of rising leverage would have also limited supply, particularly given the late stage in the economic cycle. Yet, this clearly did not turn out to be the case as we saw nonfinancial CP outstandings grow to a record high of $345bn a couple weeks ago."
It continues, "Notably, a look at the top 20 non-financial issuers whose CP balances saw the most growth year-to-date reveals that the growth was broad-based across a range of issuers as opposed to being concentrated in a few.... In fact, based on DTCC data, we estimate there are 270 non-financial issuers that currently have non-zero outstandings in the CP market versus 258 at the start of the year, with Tier 2 issuers comprising much of the difference. This suggests to us that more corporations are increasingly tapping the CP market as a source of funding, which makes sense given the relative cost of issuing CP versus accessing other parts of the capital markets."
Among the 20 issuers with the largest YTD increases, JPM lists: Exxon, United Health, IBM, Walt Disney, Cisco, TOTAL, DowDuPont, Sanofi, Nestle, BASF, Anheuser-Busch, General Dynamics, Philip Morris, Dominion, NextEra, Schlumberger, Archer-Daniels, CenterPoint, Mondelez and EssilorLuxotica.
Authors Alex Roever, Teresa Ho and Ryan Lessing state, "Indeed, a Tier 1 and Tier 2 issuer can issue 3m CP at a yield of ~2.45% (3mL − 5bp) and ~2.75% (3mL + 25bp), while access to their bank facilities could cost north of 75bp above 3mL. Alternatively, non-financial companies can access the term debt markets, but yields along the curve have generally been north of 3% (though that is coming down as Fed expectations have pushed rates lower and the curve flatter)."
They add, "Also boosting non-financial CP balances higher has been the demand for nonfinancial paper. With a flat money markets curve and technicals pushing spreads tighter, finding yield has become increasingly difficult. However, with the stickiness that generally comes with non-financial CP yields, this sector has remained relatively cheap compared to other asset classes. Indeed, a look at Tier 1 non-financial yields shows that an investor can still pick up 3-6bp over Treasury bills as the latter asset class has been much quicker to rally on the back of reduced supply and changes in Fed expectations.... Likewise, yields of Tier 2 non-financial CP remain about 20bp higher than other credit-based issuers of similar maturity."
Finally, JPM says, "Perhaps it's not surprising then that prime MMFs have more than doubled their nonfinancial CP balances YTD, from $22bn as of December 2018 to $57bn as of April 2019. As investors continue to assess the probability of Fed cuts later this year, nonfinancial CP, much like repo, could be useful in helping investors stay liquid and pick up yield at the same time, particularly as the maturity of non-financial CP tends to be less than three months."
In other news, Federated Investors' Deborah Cunningham writes that "Investors shouldn't go looking for trouble" in her latest "Month in Cash" column, saying, "Investors are overreacting to the flattening of the short end of the yield curve." She tells us, "{L]ately, you can make a strong case that investors at the short end of the yield curve are not using common sense. In May the yield curve flattened, briefly twisted (3-month and 1-year Treasury yields dipping below 1-month) and then flattened again, but with the 1-year lower. These days, it appears that the 1-year is joining the larger inversion out the curve."
She continues, "Perhaps irrational is too strong a word, but recent investor behavior is -- to use financial jargon instead of academic textbooks -- overdone. The flattener is simply not justified by the domestic economic data that, while moderating, is still strong. We are among the many who think the U.S. is not likely headed to a recession anytime soon. While significant, all of the geopolitical issues circling, such as trade conflicts, central bank easing and Brexit, hardly justify this overreaction. Nor does the likelihood of the Federal Reserve being on hold for the remainder of 2019. The issue seems to be a case of investing via group think."
Federated's Liquidity CIO explains, "But some investors may be overthinking. One of the reasons for the recent flattening is a misread, in our view, of a very technical maneuver by the Federal Reserve that investors shouldn't be tracking anyway: interest on excessive reserves (IOER). The story goes like this: by cutting the interest the Fed pays banks on the money they keep in their Fed accounts, policymakers have surreptitiously lowered rates."
She tells us, "People seem to have forgotten that the Fed has lowered IOER twice within the last six months without any market consternation. The only difference is that they were raising the fed funds target rate at the time. With rates on hold, the market seems to be perceiving the reduction as a proxy for a rate cut -- the easing that so many have already forecast. But the fact is that the Fed tightened IOER to give it more control over monetary policy from a federal funds perspective, and also to incentivize banks to move funds into the marketplace. It isn't easing."
Cunningham says, "The good news for cash managers is that money market funds remain attractive in this environment. That's especially the case when compared to Treasuries and bank deposits, whose rates are falling and weren't great to begin with."
Finally, she adds, "In contrast, flows continue to be positive into all three money fund categories (government, tax free and prime). Prime money funds have benefited because their reference rate, the London interbank offered rate, has not inverted. Media outlets have written that high-net-worth families have a significantly higher percentage of money in cash. In short, liquidity products are a solid option, even though rates are steady and look to be that way for some time."
