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Is bond liquidity a major problem? There have been a number of articles lately questioning the liquidity of bond markets, post financial crisis. This is a fairly complex situation for individual investors to understand, but this article from IndexUniverse, does a pretty good job of getting to the bottom of the matter.
The problem is that the infrastructure supporting bond trades has weakened significantly since Lehman Bros collapsed in 2008. Banks have been forced to pare holdings of corporate debt and mortgages as new regulations make it more costly to hold riskier assets and discourage proprietary risk taking. Other regulations make lower-risk Treasuries relatively more attractive as they can more easily be used to back derivatives, loans and other trades.
The fear is, should interest rates rise, many individual investors will abandon bonds, most of which are held in mutual funds. This will force bond managers to sell the underlying bonds…causing a flood of bonds to hit the market at a time when there is little dealer liquidity to absorb the shock.
This could have a dramatic effect on bond prices, this summers selloff from May through June was a taste of what could happen in fixed income markets if investors panic over rising rates.
So is bond illiquidity here to stay? There have been efforts to overcome the problem, by developing bond trading networks and even exchanges, but so far these have failed to reach critical mass. IndexUniverse also reports that Asset managers are reluctant to reclassify themselves as bond dealers, for fear of incurring heavier regulation. As a result, funds still rely largely on bank dealers to enter and exit positions.
Will all bonds be hit by a lack of bond liquidity? No, corporate bonds are deemed to be most vulnerable to liquidity freezes if rates spike. The broad swath of smaller, individual bond issues makes it harder to match buyers and sellers without intermediaries warehousing the bonds. Treasury bonds are expected to be the least badly affected.
You can read the full article here.
Todays Other Top Stories
MoneyBeat: – How hedge funds are trading Muniland. – What’s a distressed-debt fund manager to do in this Goldilocks credit market? The answer for many is to play municipal bonds. But the vulture-fund strategies don’t translate perfectly in the municipal market and the hedge funds hunting for bargains there are trying out new tactics.
BusinessWeek: – Puerto Rico distress spells Wall Street opportunity. – Puerto Rico debt is having its worst year since 1999 as a shrinking economy strains the island’s finances. For Wall Street banks and law firms, that’s a signal to tout the bonds to investors in distressed debt who don’t typically buy municipal securities.
Reuters: – Individual investors flee US municipal bond market. – Individual investors bolted from the U.S. municipal bond market in the third quarter, with data released on Tuesday showing the number of small trades spiked at the same time bond funds registered record outflows.
Chicago Tribune: – US Airways, American deal seen as positive for airport debt. – The deal American Airlines and U.S. Airways Group struck to sell gate slots at half a dozen airports in exchange for government clearance for a merger could lift a cloud that has hung over a popular corner of the municipal bond market since late summer.
Bloomberg: – Tax sales threaten to extend worst losses since ’08: Muni credit. – Buying municipal bonds usually helps individuals lower taxes. This year, amid the worst losses in the $3.7 trillion market since 2008, so does selling the debt.
Digital Journal: – Coats|Rose lawyers close innovative bond financing PID. – Coats|Rose lawyers recently closed one of the first Texas municipal bond financings secured solely by “assessments” collected through a Public Improvement District. The bond proceeds were used by the City of Lavon, Texas, near Dallas, to reimburse the developer of the Grand Heritage master planned community for water, sewer, drainage and road improvements serving Grand Heritage.
Learn Bonds: – Are bonds really in a bubble? – Despite continued fearful cries from naysayers over the past several years, the bond market hasn’t experienced the catastrophe that many continue to anticipate. But while there is no disputing the fact that we are in the final inning of a 30+ year bull run that has seen Treasury bond yields drop from the mid teens to practically zero (see below chart), predictions for an imminent, far flung bond market disaster continue to be a bit, well, far fetched in my opinion.
Before Its News: – Zacks #1 ranked government bond mutual funds. – Mutual funds investing in debt securities are among the most secure investment options which provide regular income while protecting capital invested. Funds which are part of this category bring a great deal of stability to portfolio which a large proportion of equity, while providing dividends more frequently than individual bonds. U.S government bonds funds usually invest in Treasury bills, notes and securities issued by government agencies. They are considered to be the safest in the bond fund category and are ideal options for the risk-averse investor.
4Traders: – Pimco’s Gross boosted U.S. government-related holdings in October. – High-profile fund manager Bill Gross boosted U.S. government-related holdings at the world’s largest bond fund he runs in October amid a price rally in Treasury bonds.
New Economic Perspectives: – What if China dumps U.S. Treasury bonds? – Our deficit hysterians love to raise the specter of China. Supposedly Uncle Sam is at the mercy of the Chinese, who have a stranglehold on the supply of dollars necessary to keep the US government above water. If the Chinese suddenly decided to stop lending those scare dollars, Uncle Sam would be forced to default.
Business Insider: – Where are Treasury yields heading. – I think that the 10-year Treasury yield could be in a trading range between 2.5%-3.5% through 2014 and maybe beyond. That’s mostly because I think that inflation is dead, and likely to flat-line around 1% for the foreseeable future.
FT Adviser: – Sector analysis: Corporate bonds. – While they may be doing better than gilts, corporate bonds are not turning in a particularly impressive performance.
Trading Floor: – Corporate Bond Weekly Update: Market hungry for new bonds. – Despite corporate bonds hitting highs for the year so far, the market is clearly craving new bonds and current issuances are frequently oversubscribed. The decision by the European Central Bank to cut the refinancing rate last Thursday to 0.25 percent from 0.50 percent has undoubtedly given that push fresh momentum.
Slate: – Will Noah bonds sink without a trace? – Ark Encounter, a creationist theme park, is selling junk bonds. Only problem is three years after first announcing the project, they haven’t even broken ground.
WSJ: – Barclays bowled over by yield-seeking investors. – In another sign of how starved investors are for high-yielding assets, Barclays has received around $10 billion in orders Wednesday for a bond that will yield around 8%.
ETF Trends: – Junk bond ETF faces chart troubles. – High-yield bond exchange traded funds have bounced back a bit since being slammed in the second-quarter due to speculation the Federal Reserve would move to taper its quantitative easing program.
SFGate: – Emerging markets are getting crushed again. — After a sharp sell-off during the early part of the year, emerging market stocks, bonds and currencies bounced back in September after the Federal Reserve decided to delay tapering its $85 billion monthly asset purchase program. But markets are once again getting antsy in the wake of the recent FOMC statement and improving economic data, which has reminded everyone that Fed tightening is near.
Bloomberg: – Emerging-market banks threatened by end of credit boom. – The world’s largest emerging markets recovered quickly from the 2008 financial crisis because consumers and companies went on a borrowing binge. Now that credit spree is coming back to haunt banks in those countries.
IndexUniverse: – Van Eck plans emerging agg bond ETF. – Market Vectors, the ETF unit owned by New York-based Van Eck Global, filed regulatory paperwork on Nov. 12 to offer its second emerging market fixed-income ETF, this one an “aggregate” bond ETF that will own sovereign and corporate credits denominated in dollars, euros or local currencies.
HedgeWeek: – Muzinich & Co launches short duration emerging market debt fund. – Corporate credit specialist Muzinich & Co has launched an emerging market short duration corporate bond fund.
Artemis: – More detail on USAA’s residential reinsurance 2013-2 cat bond. – Residential Reinsurance 2013-2 launched to investors last week and sees USAA looking to secure another source of fully-collateralized, capital markets backed, multi-peril and multi-year reinsurance protection from insurance-linked securities investors. Artemis has received some more detail on the transaction through conversations with investors and rating agency Standard & Poor’s pre-sale report for the deal, which covers one of the two tranches on offer.
Felix Salmon: – Cat bonds wouldn’t have helped the Philippines. – There’s no good reason to believe that a cat bond would have paid out in the wake of Haiyan. Cat bonds tend to pay out only under certain narrowly-prescribed conditions, and those conditions would probably have drawn the geographical area to be protected much more narrowly than the entire Philippine archipelago.
TheStreet: – New ETF offers protection against rising rates. – The bond market is becoming increasingly difficult to navigate as any positive economic news lead to fears that the Federal Reserve will start reducing its monthly asset purchases — the so-called tapering — causing bond prices to fall and interest rates to rise, and which is what happened last Friday when employment data was released.
Minyanville: – Don’t get trampled by rising yields. – If yields continue to rise, eventually the Fed will start to be a cost center as opposed to an income stream for the Treasury. This will no doubt raise even more questions as to the sustainability of the Fed’s programs. Yields may now be rising for good, which will trump any new band-aid the Federal Reserve tries to throw at the problem.
Bloomberg: – Vanguard bond chief says losses aren’t locked in when Fed tapers. – A reduction of quantitative easing by the Federal Reserve needn’t be a harbinger for losses with growth slow and inflation subdued, according to Gregory Davis, named last week as head of fixed income at Vanguard Group Inc.
Herald Online: – Fidelity Investments significantly expands suite of short duration bond funds. – Fidelity Investments, a leading global asset management firm with $1.9 trillion in managed assets, including approximately $890 billion in fixed income assets, today announced it has expanded its line-up of short duration bond mutual funds for investors and financial advisors with the launch of three new products.
CNBC: – Bond market under fire, but pros keep their cool. – Bond strategists are looking to hold their ground against a backdrop that has shown them far underperforming stocks and as the market holds its breath over where rates are going.
Reuters: – As assets surge, bond investors worry over liquidity traps. – Asset managers’ bond holdings are surging as banks that traditionally facilitated trades in debt markets scale back, raising fears that increasingly one-sided markets are at a greater risk of frantic selloffs.
ETF Trends: – 10 bond ETFs with yields above 5%. – A list of bond ETFs that have 30-day SEC yields north of 5%. Durations are included as well as comments illustrating what investors can expect with these ETFs. Only pure bond funds are included. That means no ETFs with “bond-like” traits such as REIT, MLP, preferred stock or business development funds.
ValueWalk: – Mutual fund, ETF flows show growing interest in equities. – People have been talking about the Great Rotation, the idea that everyone is going to pull their money out of bonds and put them into equities, at least since tapering was first announced, and while it’s easy to get carried away with such a catchy name, mutual fund and ETF flows show that investors really are losing interest in fixed income products.
Barron’s – A smart bond strategy. – By holding bonds to maturity, you can take some of the uncertainty out of fixed-income investing, says a Wells Fargo pro.
A low default environment is a positive for high-yield bonds & bank loans in 2014 but much of that already priced in.
— AnthonyValeri (@Anthony_Valeri) November 13, 2013
Lots of articles on lack of bond mkt liquidity. This will likely end with mom & pop selling a HY ETF & getting First Data cash bonds in kind
— David Schawel (@DavidSchawel) November 13, 2013