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Bond Market Liquidity Not Impaired by Rule Changes

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Bond Market Liquidity Not Impaired by Rule Changes

Republished from: “BusinessWeek”

Rising corporate-bond trading signals that liquidity is robust even as Wall Street’s biggest banks cut their inventories of the securities in response to new rules and regulations, according to JPMorgan Chase & Co.

Average daily trading volumes in U.S. investment-grade corporate bonds has increased 18 percent since the end of April from the same period last year, while dealers pared holdings of the debt by 54 percent in the five weeks ended July 3, data from the Financial Industry Regulatory Authority and the Federal Reserve show. The so-called bid-ask spread that dealers charge in bond trades grew 3 basis points in the period, less than half the increase in 2011 amid Europe’s fiscal crisis.

Almost five years after the collapse of Lehman Brothers Holdings Inc., credit markets are becoming better oiled to withstand stress, JPMorgan analysts led by Nikolaos Panigirtzoglou wrote in a July 12 note. Rather than driving liquidity by taking big positions, banks are simply acting as the go-between for buyers and sellers, while the number of market makers increases and electronic systems emerge to facilitate trading, they said.

Market Buffers
“The only way for the market to work when dealers can’t act as a buffer is if you’re able to match a seller from a mutual fund with a buyer from an institutional investor, and so far that has worked,” Bank of America Corp. credit strategist Hans Mikkelsen said in a telephone interview. “Back in the old days, dealers were able to act as buffers in the market: they would accumulate bonds on their balance sheets, and that’s not happening anymore.”

Dollar-denominated, investment-grade bonds lost 5 percent in the two months ended June, the biggest declines since the 2008 financial crisis, as concern mounted that the Fed was preparing to scale back stimulus measures that have bolstered debt prices, Bank of America Merrill Lynch index data show.

“The recent volatility episode has not significantly affected either trading volumes or the bid-ask spreads of the largest U.S. high-grade corporate bonds,” the JPMorgan analysts wrote. “Broker-dealers have become a lot more efficient and can sustain a high volume of trading with a smaller inventory.”

Record Offerings
Investors snapping up a record pace of new corporate-bond sales may have muted trading of existing debt earlier this year, Alexander Sedgwick, head of research at MarketAxess Holdings Inc., said in a telephone interview. “With low volatility, there hasn’t been as much of an impetus up until the last couple weeks to move any money around,” he said.

A MarketAxess index that tracks the bid-ask spreads, or the difference between where bonds are bought and sold, for the 1,000 largest and most actively traded issues widened to 10.5 basis points on July 15 from 7.5 on April 29, according to the data from the electronic bond-trading platform owner. Over a five-month period ended Sept. 19, 2011, as markets were being roiled by concern a Greece default would jeopardize Europe’s common currency, the spread widened to 15.6 from 8.5, the data show.

“Since the crisis, we’ve generally run portfolios with higher levels of liquidity, knowing that the markets were going to be more volatile and we want to be able to be nimble,” said Ashish Shah, the head of global credit at AllianceBernstein Holding LP, which oversees $257 billion in fixed-income assets. “That lesson still holds. You can’t give up that liquidity.”


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