Although foreign investors continue to be the largest purchasers of most types of US bonds, this sector showed less interest in Treasuries than in the past, shifting assets into short-term repurchase agreements in Q1 2006.

In same quarter, the offer of new bonds rose due to seasonal issues by the US Treasury and to domestic corporations resorting to record levels of bond issuance to finance stock buybacks.

With foreign investors moving out of Treasuries and with heavy new bond issues by the government and private corporations, bond prices fell.

Broader Support for Bond Markets

Higher interest rates and uncertainty about equity markets attracted increased flows to bonds from insurers, funds, banks, and households.

If the Federal Reserve continues to push short-term interest rates upwards and if foreign investors continue to move into short-term fixed investments, such as repurchase agreements, long-term interest rates may be forced higher.

However, considering the seasonal nature of Treasury issues in Q1 2006, the declining federal fiscal deficit, and the (perhaps) temporary nature of corporate borrowing to finance stock buybacks, it is not clear whether record levels of bond issuance will persist throughout 2006.

The following graph combines flow of funds tables for Treasuries, agency bonds, corporate bonds, and municipal bonds and shows bond issuance rising to high levels relative to demand.

Demand for Bonds: US Market: Q1 2006
Demand for Bonds: US Market: Q1 2006

Massive issuance of bonds by non-financial corporations, largely to finance an extraordinary level of stock buybacks, helped force bond interest rates upwards in Q1 2006. (See Flow Table F212).

The annualized rate of bond issuance by non-financial corporate business rose to $240.4 billion in Q1 2006, four times the issuance rate of 2005.

The graph shows that, for years, the principal issuers of corporate bonds into the U.S. market have been the financial sectors (green bars) — mainly issuers of asset-backed securities raising funds for mortgages and consumer finance.

Principal Issuers of Corporate & Foreign Bonds
Principal Issuers of Corporate & Foreign Bonds

Non-financial Corporations Raise Money For Buybacks

The annualized rate of issuance of corporate bonds by the financial sectors rose from $679.3 billion in 2005 to $725.4 billion in Q1 2006, while the financial sector’s share of the issuance market fell from 90% to 70% due to the extraordinary level of bonds issued by non-financial corporations.

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Disbursement of corporate cash through dividends and stock buybacks totaled $1,073.5 billion in Q1 2006 (annualized quarterly data), compared to net corporate profits after tax of only $509.5 (also, annualized quarterly data), according to the Federal Reserve flow of funds accounts for Nonfarm Nonfinancial Corporate Business.

This massive distribution of corporate cash that exceeded net profits after tax, was financed by borrowing with credit instruments (mainly bonds and mortgages) and by drawing down reserves for depreciation. Increased borrowing through credit instruments for the quarter (annualized) amounted to $232.1 billion.

The low point in cash dividends seen in Q3 2005 ($179.3 billion) was dramatically reversed in Q1 2006, with dividends reaching $486.7 billion (quarterly, annualized).

It seems unlikely that corporations will be able to continue to simultaneously increase dividends, buybacks, and borrowings at a rate faster than net profits after taxes for much longer.

The use of borrowed funds to buy back corporate stock and thereby boost prices and give value to stock options would seem the height of executive profligacy, imprudent management, and fiduciary failure, but never mind … fiddle-de-dee … tommorrow is another day.


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