Bond Trading Frenzy Risks Giving Market Makers a False Sense of Security
(Bloomberg) — On the surface, the corporate bond market has never looked more stable and liquid. In the US, the market recorded its busiest month ever for trading volume in September.
Most Read from Bloomberg
But history suggests that the ability to trade smoothly is only there until you need it, and the International Monetary Fund warned this week that tight spreads are raising the risk of an abrupt repricing of credit.
Typically, the volume of trades rises when investors crave risk, according to Blair Shwedo, head of fixed income sales and trading at U.S. Bank. Securities that are relatively easy to sell can also help money managers limit losses and return cash to investors redeeming when markets sell off.
“My concern is the kind of self-fulfilling prophecy of everybody thinking liquidity is good and getting better,” said Shwedo in an interview Wednesday. “Does that lead us to a point where, because everybody’s under the assumption that liquidity is really good, the music stops and we see a drastic deterioration?”
At the moment, credit spreads show bond markets priced for perfection, buoyed by a robust outlook for the US economy and the likelihood of more policy easing from the Federal Reserve. That makes them more vulnerable to swift repricing if volatility spikes — as it could in the aftermath of November’s presidential election.
Shwedo does not see any immediate signs of a deterioration in liquidity, barring an exogenous shock. The rise of e-trading, portfolio trades and exchange-traded credit funds gives dealers greater ability to provide pricing than they had in 2020 when the pandemic roiled markets, he said.
More non-banks also make markets, with platforms like MarketAxess Holdings Inc. and Tradeweb Markets Inc. becoming popular as credit is increasingly traded electronically. More users enhances liquidity, which further boosts orders.
That helped September become the biggest month ever for US investment-grade trading, with an average daily volume exceeding $43 billion, according to Bloomberg Intelligence. Electronic activity accounted for 50% of high-grade bond trading in September, based on Coalition Greenwich data.
Portfolio trading, where investors buy or sell a block of bonds in one or two transactions, are now a key driver of the ability to trade smoothly, according to Barclays Plc. It’s boomed in the last few years, rising to 25% of dealer-to-client volumes in September from virtually 0% in 2018, analysts led by Dominique Toublan wrote in a note last week.
The IMF, however, also warned this week that the rise of nonbank financial institutions means “the availability of market liquidity in times of stress has come into question.”
Election Anxiety
Investors derive a sense of security from being able to easily and cheaply move bonds, but if vote counts drag on, results are contested or there are fiscal surprises then buyers could struggle to find a bid when global markets gyrate.
“You never know where these elections are going to end up. You never know what kind of volatility they might introduce,” said Jonny Fine, global head of investment grade debt at Goldman Sachs Group, who was speaking of presidential votes in general, not just the US.
Any number of things could cause a liquidity crunch, according to Bloomberg Intelligence analyst Brian Meehan. Macro data could turn, undermining faith in the strong economic growth narrative, Donald Trump could win the election and enact punitive tariffs that accelerate inflation, or more zombie companies could struggle to refinance, he said.
“It just looks like a disaster in the making,” he said in a phone interview Wednesday.
Week in Review
Boeing Co. will likely raise as much as $20 billion in equity to shore up its balance sheet after the troubled planemaker reported it expects to burn cash in 2025, according to a research analyst at Bank of America Corp.
Defaults in an opaque corner of China’s local debt market have surged to a record high, ensnaring investors who’d assumed the securities had an implicit guarantee from the state. Failures of so-called non-standard products, which are fixed-income investments that aren’t publicly traded, have surged to record levels.
Investors are piling into European junk bonds at the fastest pace in three years in a bet that interest-rate cuts in the region will outpace those in the US.
In the US corporate bond market, prices are signaling that the outlook for blue-chip companies is brightening. Derivatives traders, however, don’t seem so sure. The divergence may be a sign that investors have some doubts about how much corporate bonds have gained relative to Treasuries in recent weeks.
Procter & Gamble Co. tied its own record for selling a 10-year US corporate bond at the narrowest spread to comparable Treasuries.
Banks and private credit firms are competing to provide at least $5 billion of debt financing to help fund a potential buyout of Bausch + Lomb.
Chinese regulators are cracking down on misconduct in the world’s second-largest corporate bond market, as they seek to reduce financial risk. The country’s securities watchdog said it suspended for six months the corporate bond underwriting business of Central China Securities Co. and Kaiyuan Securities Co., according to statements dated Oct. 18.
Companies have borrowed a record $1 trillion in the US leveraged loan market this year, driven by repricings that slash borrowing costs on the risky debt.
Corporate bond investors are facing losses on debt tied to Tapestry Inc.’s failed acquisition of Capri Holdings Ltd. as the former could look to redeem $4.5 billion it borrowed to fund the deal.
Analysts at Goldman Sachs Group Inc. and BNP Paribas SA are forecasting the end of a rally that has turned the world’s credit market into a uniform mass of expensive assets. They recommend taking a more defensive stance and positioning for the gap between safer and riskier debt to widen.
Some Wall Street banks have started to reduce exposure to debt from Apollo Global Management Inc.-backed Brightspeed that has been stuck on balance sheets after a buyout two years ago.
Spirit Airlines Inc. is in talks with Frontier Group Holdings Inc. about filing for bankruptcy to facilitate a takeover by the rival discount carrier.
Bankrupt hedge fund Weiss Multi-Strategy Advisers LLC and its largest creditor, Jefferies Financial Group, are discussing a potential settlement that would resolve litigation related to the collapse of George Weiss’ eponymous firm.
On the Move
Wells Fargo & Co. recruited Barclays Plc veteran Peter Thomson as a managing director in the syndicate unit of the bank’s leveraged finance business.
Barclays said it has hired Anastasia Chernetskaya, a leveraged loan and high-yield bond syndicate banker, from Deutsche Bank in London.
Insurance company Pacific Life has hired Richard Talmadge as head of private asset-backed securities.
HSBC Holdings Plc has recruited Lawrence Xu from Goldman Sachs Group Inc. as its head of European financials credit trading.
Marathon Asset Management is preparing to issue collateralized loan obligations that meet European regulatory requirements, packaging the securities through a newly created investment advisory unit called Bryant Park Funding CLO Management.
–With assistance from Neil Callanan and Dan Wilchins.
