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Bond traders are having a hard time of it in 2014, as U.S. government-bond trading continues to decline despite the size of the market tripling in the last decade.
One reason for the slowdown is that banks are reducing fixed-income inventories in response to risk-curbing regulations, such as the U.S. Dodd-Frank Act’s Volcker Rule, which limits the amount of their own money they may use to buy and sell riskier securities. But that isn’t the only reason, the Wall Street Journal reports that declining velocity is also having a detrimental effect on the market.
Bond velocity is similar to the velocity of money. But instead of measuring the rate at which money is exchanged for goods and services, it measures the rate at which bonds are traded. Simply put, it is the ratio of trading to outstanding bonds. The WSJ said.
And bond velocity is falling. According to data from the Securities Industry and Financial Markets Association. The average daily volume of bond trading was more than 3% of the total outstanding stock of bonds between 2002 to 2008.
This year however, it has fallen to 1.79%. That compounds the negative impact of low issuance, so that traders are buying and selling a smaller share of a bond market whose growth has slowed.
The “Volcker rule” is one of the reasons velocity is falling, with bans on short-term proprietary trading, making bonds less likely to change hands. Banks are also moving billions of dollars of bonds into held-to-maturity portfolios, meaning they are unlikely to be traded.
But the Federal Reserve is also playing a role. Thanks to quantitative easing, it now owns a sizable portion of the bond market. And since the Fed doesn’t plan to sell its QE portfolio, bonds sold to the Fed effectively lie dormant.
The good news is that the end of quantitative easing might allow velocity to rise somewhat. That would be good news for bond traders—and the banks that employ them.
Todays Other Top Stories
LearnBonds: – Consider this before abandoning bonds for bond equivalents. – Income-focused investors would be well advised to pay special attention to their inflation-adjusted yields.
Bloomberg: – Puerto Rico bonds have long-term value, OppenheimerFunds says. – The value of Puerto Rico bonds will increase in the long term even as their prices plummeted to record lows after passage of a debt-restructuring law, OppenheimerFunds Inc. said.
Boston Journal: – Roadway bonds lead U.S. municipal sales next week. – Roadways, ports and water projects lead an estimated $ 4.5 billion U.S. municipal bond and note sale calendar next week, including a $ 250 million deal from the Indiana Finance Authority on behalf of a public-private interstate highway project.
Bradenton Times: – What is duration, and why should I pay attention to it? – The Federal Reserve’s actions over the next year could be important to bond markets, particularly if and when the Fed decides to increase its target interest rate. Since bond prices typically move in the opposite direction from yields, rising bond yields will translate into a decline in bond prices.
Bloomberg: – Bond investors ignore cries of `wolf’ and pile back in. – Investors are tired of analysts predicting the bottom will fall out of the bond market.
FT: – Fed must not linger too long on QE exit. – The end of easy money will hit bond markets hard if not timed right.
Morningstar: – Bond investors still playing chicken with the Fed and rates. – At midyear 2014, taxable-bond CEF categories like bank loan and high yield–which had strong runs last year–have had muted success, while preferred stock leads the pack.
FT Adviser: – Strategic bond is bright spot in fixed income. – In the first four months of 2014, the sector was the only one in IMA fixed income to record positive net retail inflows.
Bloomberg: – PIMCO says Canada is ‘worst’ market for bond transparency. – In the 20 years that Ed Devlin has traded bonds across three continents, the market of his native Canada has earned a dubious distinction in his eyes.
NASDAQ: – Yield curve flattens as investors consider Fed view. – Long-term Treasury prices edged up Monday while shorter-term prices fell, as investors continued to reconsider the Federal Reserve’s monetary policy outlook.
Wall St Cheat Sheet: – 3 ways rising interest rates change the game. – It seems that the Treasury bond market, which has been incredibly strong this year, might be topping out.
Geopolitical Monitor: – U.S. Fed should destroy Gov. bonds. – The US Federal Reserve Board should destroy the government bonds it holds to resolve the impasse over the debt ceiling. This maverick move could allow the government to generate the demand needed to push the economy back toward full employment, without creating a major debt burden for future generations.
Bloomberg: – Bond anxiety in $1.6 trillion repo market as failures soar. – In the relative calm that is the market for U.S. Treasuries, a sense of unease over a vital cog in the financial system’s plumbing is beginning to rise.
Businessweek: – Goldman Sachs brings forward rate forecast before U.S. auctions. – Goldman Sachs Group Inc. brought forward its forecast for the Federal Reserve to raise interest rates after U.S. employers added more jobs last month than forecast, sending three-year Treasuries lower for a fourth day.
High Yield Bonds
S&P Capital IQ: – Inflows to high yield bond ETFs offset mutual fund outflows. – Retail-cash inflows for high-yield funds totaled just $90 million in the week ended July 2, compared to the $619 million inflow last week. This week’s number represents the eighth inflow in the past nine weeks, for a combined $3.2 billion inflow over that span.
Advisor Shares: – A perspective on high-yield spreads. – There have been recent headlines about yields in the high-yield market hitting all-time lows. Yes, this is true, but let’s put this in some context.
BT Premium: – Boom time ahead for high-yield bonds. – The high-yield bond market is on track for a strong second half following a better start to 2014 than anyone expected in both volumes and returns, thanks to lower underlying rates, a compression in spreads and a rebound in mergers and acquisitions (M&As).
ValueWalk: – From tactical to core: The case for emerging market debt. – A dominant theme over the past few years has been the search for yield, particularly when accompanied by low volatility. Given the meager return on cash, investors have been moving into credit in search of additional returns and into asset classes with perceived levels of low volatility.
FT: – Rumours of the death of emerging market bonds are exaggerated. – Foreign investors did not cut their holdings of emerging market sovereign debt during the so-called taper tantrum last year, according to analysis by Standard Chartered, the emerging market-focused bank.
Reuters: – Willis expects record non-life catastrophe bond volumes this year. – The non-life catastrophe bond market issued record volumes during the second quarter, Willis Capital Markets & Advisory (WCMA) said, adding that it expects full-year issuance to be between $8 billion and $9 billion.
WSJ: – Diversified investors, don’t lose your balance. – Investors with diversified mutual-fund portfolios would have been hard pressed to lose money in 2014’s first half, but that doesn’t mean it’s time to go all-in on stocks or bonds.
Cliff Smith: – 2 Tactical municipal bond strategies for non-qualified retirement portfolios. – Two tactical strategies employing tax-free, municipal bond ETFs, and is best suited for non-qualified (taxable) retirement accounts.
Trustnet: – Is the stellar performance of risky bond funds coming to an end? – There is a significant inflexion point in the fixed interest market, according to FE Alpha Manager Ian Spreadbury, who believes now is the time to take credit risk off the table in favour of interest rate risk.
The Intelligencer: – Rising interest rates could hurt your bond fund. – Mom told us not to put all of our eggs in one basket, and so it is with most all properly allocated investment portfolios. Most well-balanced portfolio’s contain at least a combination of stocks, bonds, cash and other asset classes. Today’s focus is on your bond funds and the risk that rising interest rates may have on this type of fund.
Citywire Wealth Manager: – Pimco unveils European short duration bond fund. – Pimco has launched a mirror version of its behemoth $14.3 billion Short-Term fund for European investors.Domiciled in Ireland, the Pimco Global Investor Series US Short-Term fund will invest in a wide range of global high quality, short duration fixed income securities.
ETF Trends: – An international bond ETF that hedges foreign currency exposure. – Currency risk plays a large role in overseas fixed-income positions. Nevertheless, investors can consider an international bond exchange traded fund that hedges against changes in the Forex market to limit potential losses due to a weakening foreign currency.
ETF Trends: – Rising rates defense and yield in one ETF. – There are myriad ETFs with which to defend against and profit from rising rates, including hedged plays that short Treasuries while being long other bonds. That group includes the WisdomTree BofA Merrill Lynch High Yield Bond Zero Duration Fund.
In the long run the greater danger is that the curve will get behind the Fed (as it has been for most of the last 6 years). #CurveFed
— Andy Harless (@AndyHarless) July 7, 2014
World awash in liquidity “@Royal_Arse: insane to think that negative yields on sov bonds are nearly ‘common’!
— Cate Long (@cate_long) July 7, 2014
*PREPA ANNOUNCES AGREEMENT WITH LOC PROVIDERS, MAY DELAY CERTAIN PAYMENTS CURRENTLY DUE UNTIL JULY 31
— Brian Chappatta (@BChappatta) July 7, 2014