Corporates won’t trade through Treasuries

By Felix Salmon
August 17, 2010
Fortune.com today:

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A rather startling pronouncement pops up on Fortune.com today:

“I wouldn’t be surprised if someday JNJ trades at a spread below Treasurys,” says Jack Ablin, Chief Investment Officer, Harris Private Bank. In other words, Johnson and Johnson yields could dip below the so-called risk-free yield on government debt.

Ablin might not be surprised, but I would be absolutely astonished. (Remember that Ablin is talking about Johnson & Johnson’s bonds, here, not the dividend yield on its stock.)

In the world of emerging markets, occasionally you’ll find corporates which trade “through the sovereign”. Generally, those companies are multinationals with strong and predictable dollar-denominated income streams, and the comparison is with dollar-denominated bonds issued by their home country.

It’s another thing entirely, however, for a company to trade at a lower yield than its home country can borrow in its own currency. And when it comes to the US dollars and Treasury bonds in particular, I’ll quite happily go out on a limb and say it’s simply not going to happen.

For one thing, if there’s a sell-off in Treasury bonds, that’s most likely going to be a result of worries about inflation — which eats away at Johnson & Johnson’s coupons just as much as it eats away at the US government’s. The only way for JNJ to trade through Treasuries would be if somehow there were worries that the US government was simply not going to pay some of its bonded obligations — while at the same time there were no worries at all about JNJ making its coupon payments. I can’t see it.

What’s more, Treasuries come with a substantial liquidity premium attached: to a first approximation, you can buy or sell them in any quantity, at any time, without moving the price. That’s very valuable — and it doesn’t apply to JNJ bonds. It’s also why Treasuries trade at lower yields than other securities without any credit risk, like World Bank bonds — which are guaranteed not only by the US but also by all the other World Bank shareholders.

So I’ll happily give Mr Ablin generous odds that JNJ bonds will never trade through Treasuries. Alternatively, I’ll buy some kind of financial instrument which pays off if JNJ never trades through Treasuries. The only problem is that no one would be willing to sell me such a thing.

Update: In the comments, tyler7 brings up a notorious Bloomberg article from March, which I dealt with at the time. People are always on the lookout for this kind of thing, but it never bears a thorough double-check.

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