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Now On The Endangered Species List: Bond Traders
The topic of collapsing bond market liquidity (and in many cases, volume) is not new: it has been covered here for over 3 years, as we observed the amount of 10 Year equivalents soaked up by the Fed week after week and month after month, to the point where even the Treasury department agreed that in its quest to soak up "high quality collateral", the Fed is making the bond market dangerously illiquid. It got so bad that in the fourth quarter of last year, the US banks posted the worst collective results across what is typically their most lucrative, Fixed Income Currency and Commodity division, since Lehman.
And yet while the bond market may have gotten so fragmented in recent months that even Bloomberg was amazed at how little trading volume it necessary to make a price impact, the amount of bond traders (and certainly salesmen), and certainly their bonuses, appeared to only go up. "Appeared" being the key word, however, because as Bloomberg reports, "the average number of dealers providing prices for European corporate bonds dropped to a low of 3.2 per trade last month, down from 8.8 in 2009, according to data compiled by Morgan Stanley."
Curiously, what is happening in the bond market is comparable to parallel developments in stocks, where an ever smaller group of companies, with an ever greater market cap (here's looking at you AAPL, AMZN and V), determines the leadership of not only the NASDAQ and the DJIA, but the entire S&P500 itself: a phenomenon we dubbed the "CYNK market", in which prices keep rising on lower and lower volumes, until eventually the selling begins, and since there is nobody to buy (and certainly no shorts left to cover), and hence no liquidity, trading in the security is halted indefinitely, making sure those paper gains remains such in perpetuity.
Bloomberg cuts to the chase:
The decline in trading is making it harder for investors to buy and sell company securities, raising concern that it will be difficult to get in and out of positions in times of market stress. Regulations introduced since the financial crisis, and meant to reduce risk-taking, are eroding the financial rewards of trading and prompting banks to reduce their inventories of securities.
Profitability from trading bonds is elusive,” said Gianluca Minieri, Dublin-based global head of trading at Pioneer Investment Management, which oversees $244 billion. “Traders are only willing to buy and sell when the overall cost of capital of that trade makes sense and this reduces the level of trading volumes in the market.”
Actually, judging by the record surge in bond-funded buybacks, traders are willing to buy in any case, completely ignorant of the cost of capital, and will gladly hand over "other people's money" to any management team that will ask for it, irrelevant if the "use of proceeds" is simply to pad management's own year-end bonus pool through equity-linked compensation, which in turn is facilitated by a record amount of corporate stock buybacks. Buybacks which, as a reminder according to Goldman, will be major source of stock buying in the S&P 500 now!
Call it the CYNK "market", call it the pulling-yourself-by-the-bootstraps "market", just don't call it a market.
But enough about bond-funded stock buybacks; back to bonds and bond traders, where one is either being laid off or has extensive opinions on what happens next, ranging from the concerned...
“The liquidity of the bond market has changed fundamentally in the last five years and it is the issue we are most concerned about,” said Jon Mawby, a London-based fund manager at GLG Partners LP, which manages $32 billion. “Banks are less willing to take on risk, which means that we have to think about what we can we do to mitigate the liquidity risk their reduced balance sheet capacity introduces.”
... to the outright idiotic:
Reduced trading of corporate bonds should not be a big concern for investors because they should buy the notes and hold them to maturity, rather than trying to get out at the at the first signs of market stress, said Brian Scott-Quinn, the non-executive chairman of the ICMA Centre at Henley Business School. “Bonds are designed to be buy-to-hold, the idea you should have a lot of liquidity is nonsense,” said Scott-Quinn. “One problem we have with the system is not enough capital is patient capital willing to sit out the ups and downs in the market, but instead pays a price for instant liquidity.”
Sure: it is all about buying-to-hold... if one is trying to justify a losing position on the books (or to bail out an entire financial system hence the halt of Mark-to-Market across the entire US financial system in the spring of 2009), or if one has an infinite balance sheet such as a central bank. For everyone else, nothing would spur panicked selling like more selling, as the self-fulfilling prophecy of margin call-driven liquidations spreads like wildfire.
The problem is that once the selling begins, there will be nobody to buy:
Euro-denominated corporate bonds got an average of 3.4 dealer quotes per trade last week, up from 3.2 recorded in January, the lowest in Morgan Stanley data that goes back to August 2009 and is based on dealer prices compiled by Markit Group Ltd. for bonds in its iBoxx indexes. Quotes for bonds in pounds fell to a record low of 3.6 last week from a peak of about seven in 2011, the data show.
And just like the US housing market, where everything but the ultra-luxury segment is sliding fast all over again with the US middle class on fast-track to extension, so with stocks, i.e., Apple, and with bonds, i.e., Treasurys and the highest rated corps, increasingly more trading and liquidity is only focused on the Top 10 most popular and traded names... then Top 5... then Top 1, until everyone just passes a few "hot potato" securities back and forth to one another, in hopes that one will not be the last one holding said potato when the central bank music stops and the last game of musical chairs ends with tragic consequences. And "one" is also precisely how many traders will be left when it is all said and done.
In the meantime, to all the recently and not so recently unemployed bond traders out there who used to worry about the downside: thank the Chief Risk Officer of the capital "markets", the central banks, for eliminating all downside risk in perpetuity or at least until all faith in central bank collapses, but not before your job becomes extinct.
Instead, just do like the E-trade baby and shift your attention to stocks. There, the "strategy" is far simpler: just BTFATH.
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"These are the times of fast foods and slow digestion;
tall men, and short character; steep profits, and shallow relationships.
These are the times of world peace, but domestic warfare;
more leisure, but less fun; more kinds of food, but less nutrition.
These are days of two incomes, but more divorce;
of fancier houses, but broken homes.
These are days of quick trips, disposable diapers, throw-away morality,
one-night stands, overweight bodies, and pills that do
everything from cheer to quiet, to kill.
It is a time when there is much in the show window
and nothing in the stockroom;
a time when technology can bring this letter to you,
and a time when you can choose either to share this insight,
or to just hit delete." GC
This has always been a cyclical phenomenon in the Investment Banks. Some years thin, some years fat across all the different departments, layoffs, hirings all usually at breakneck speed. With bonditos being an OTC market, the lack of dealer participation becomes particularly pronounced. And the European markets for corporates never were as well developed as the US one. Not to say that things have not deteriorated across the board.
BUT
Some senior folks at most the Big Banks should be taken out and shot, for with the ability to fund positions at next to shit's free, and with the price action of debt the last year (long bonds up 20+%) you'd a thunk there'd be some big assed Happy Happy Joy Joy P&L's on bond desks, but no?
Hmmmmmmmmm....
Lichi, dere's sumptin' wrongk here.
Shooting is too good for them, but we'll have to make do.
Without giving up any trade secrets knucks, do these rates have some of the management stiffs spooked?
I'd be nervous as hell flying blind like we are now. No text book on this crappola.
1929 was a Bond crash. We're facing a Bond bubble now and a Govt default. Not an equity bubble , not even a debt bubble.
Nope, no trade secrets to be had, because aside for some very short lived periods of time we've not had negative rates like this.
I personally, for example, traded some t-bills at negative rates once, but that was because I bought in a position from Salomon Brothers who couldn't/wouldn't make delivery for a state collateralized (mandatory by law) money operating account, and other time seen negative bill rates when there was panic in markets (2007-9, for example) when folks had to park Big Blocks of funds and just wanted their money back, no risk, so they looked upon it as a charge, or fee.
Likewise during periods of the Great Depression (the old one) bills traded at negative rates for the very same reason... which was accompanied by deflation, likewise.
I'd said to these guys (several are with the bigger "commercial" and "investment" banks) that they needed to ask a few of their old timers, some worldly experience, not just the last few years, to literally preform some significant thought experiments about this. What are the implications? I say older hands because need some folks seen the shit really fly, like Volcker's Saturday Night Massacre, etc.
For example. In the Netherlands (one of them countries up thata way, don't matter which) there supposedly were some home loans written with negative rates. Let's assume that to be the case. OK, so then ah hah says I to myself, I'd go out and borrow a bazillion bucks, because every dollar I borrow at a negative rate, I get paid interest. So the more I borrow, the richer I become. So I quit working. Just retire on a beautiful income of debt LOL. So everybody else catches on. And they lever up as well and they retire. Pretty soon, we've nobody producing goods or service. What is the outcome?
Take it a step further. What justification for unlimited government debt? Uncle Sam borrows and gets paid to do so. Politically, the country says lookie, what a great credit rating, we 're doing it right, buys up the entire nation , we all become.... What is the outcome?
A lot of thought needs to be placed into the cause/effect relationships. Because the system as we know it does not support such a debtor creditor relationship. Essentially borrowers become lenders and vice versa.
Nope, no terribly comfortable insights.
But...... He who owns a piss load of high quality interest bearing debt is gonna be KING.
For equities, I can make arguments of both great and dismal outcomes. I don't know the conclusion. SO much will depend upon the real economy and perceptions!
Just think of discounting future earnings streams at Negative Rates. They don't get smaller, they get bigger!
The more a government borrows, the more it pays down it's debt!
Very serious considerations that I've not yet come to comfortable terms with.
Thought experiments, yes. Real estate could be goosed, but it is somewhat self-limiting. It always comes with taxes, maintenance, and wife...
My first thought was the carry trades will go ballistic. Why not borrow in Japan and invest in Russia? If you're wrong, you need another job, but if you are right, you can buy Switzerland.
Hmmm. Where's that offer for an American Express card?
damn that was beautiful. ZH should have a sister website but in george carlin fashion.
This is crucial. I don't know what will break first, but I still think negative interest rates will destroy the bond markets.
Mr. Yellen is jellin' as usual. Sometimes it helps to be clueless.
So Kaiser, talkin' to a bunch of guys that I know, all financially savvy at differing levels, but knowledgeable, they're all from the least as in agnostic to the believers as in done deal, that we're gonna have negative rates here in the US as well....
I'm personally thinkin' we're gonna see it, too, but Jesus if I'm not feeling too much as an outlier.
What's your take?
I like Peter Lynch's approach to crises. You have to think about the buyers, and who can't buy for regulatory reasons.
If you run a bond fund, allocation fund, hedgie, whatever, you're paid to take risks, and do things at a scale retail can't do, so you're comped. But how in the hell can a pension fund or insurance pool buy into a certain loss? Those guys and their lawyers are gonna be sweating bullets.
I agree about the negative rates. Already baked in the cake. Everybody is coming to the last supper for yield and that's us.
All I'm sure of is it won't be boring. Money market funds should die first. Maybe that will wake up a few volk.
The moar bonds move higher the moar equities move higher.
As Governments simply buy all the debt they'll get some equity kickback while everyone else is stuck with an inflation and The Debt Bomb.
Once the Mars Express is built and fully loaded with folks prepping their escape we'll all understand.
Did you ever consider corporate bonds over municipal bonds? When Govs are in danger of defaulting what else do you have?
Munies, corporates, and States can't print, so not really. Once things get really dicey, I like utilitlies and quasi-utilities: pipelines, power and water companies, railroads, anything that has to be maintained come what may, but the sequence of disasters is the key.
You don't want to be early.
Good thoughts on the utilities, quasi-utilities.
That's it. For me right now, it's all about dancing to the rhythm when I can hear it. I can't play this any other way. No one can anticipate the order of disasters to come, so we try to play it safe but there's no real safety. I sold all my Bonds, I'm in cash waiting out his year for equities and/or pms to come down. Eventually I will buy more blue chips, gold and maybe some corp bonds.
When Govs are in danger of defaulting what else do you have?
gold and silver...beans and bullets...
Yes, that "what do we do" when the entire term structure (extreme case) is negative, conundrum.
One of the guys I was speaking of said simply, "Buy Stocks"
And much to my immediate dismay, he may be right. For the dividend income!
Utility stocks, the old line Grandma and Grandpa stocks. Or even growth stocks. Can make arguments for that....
Becomes somewhat unnerving, to say the least.
But think of discounting the future earnings stream at negative rates. If the 1 year rate say (for simplicity) is 10%, then if it's a positive 10%, the year's out $1 earnings are worth 90 cents today... simple DPV. If however, that rate is a negative 10% then that $1 one year hence is worth $1.10 today!
Jesus! DPV in reverse!
The value of that cash flow is himongoloid! Stocks to the moon under that scenario. That's just the math of it!
Very unsettling!
It would make flipping houses look like a lemonade stand.
Every cab driver would also be a bond/real estate arb. Doesn't mean it won't happen. I really wonder if they haven't lost control already. Yellen admitted she doesn't know HOW to raise rates in this environment. Raise the discount rate when no one borrows from the Fed? Big woop.
Exactly. We're back to the Volcker Paradigm
What is required to "tighten" is the draining of reserves form the banking system. It's the quantity of money matters. Raising a window or FF rate is inconsequential aside from giving the banks a boost in a base rate to raise for commercial/retail.
The problem is so bloody much money floating about the system.
Money (reserves) need to be drained until rates rise on their own accord as per Volcker's quantity approach as opposed to the olde fashioned (and newer MMT rate based target approach... which are fallacious, in any case.)
Would be a real humdinger to truly tighten these days.
But that would get rates back into positive territory, no doubt!
I agree with you, that it seems under any real rational perspective that given where we are, by definition, control has been lost.
What the fuck. Let's get some camera sticks and take some selfies.
The Fed is engaged in at least 3 major manipulations:
1. Selling short the PM's to suppress price in an effort to keep the dollar as the world's reserve currency
2. Monetizing the federal debt, using stealthy back-door approaches through Belgium and who knows where else. Fed denies doing QE but balance sheet shows otherwise. The deficits are being funded, they just aren't calling it QE anymore
3. Equity markets are being pumped up on miniscule volume by having the bankster algos simply bid and offer (and accept) higher prices in a deliberate attempt to continue the "wealth effect" game. There is no effort to engage in honest price discovery, it is simply the world's largest ever pump-and-dump scheme, currently still in the "pump" phase.
All 3 are bullshit and will end ugly, with the time, catalyst, and circumstances yet to be determined.
WANTED: Engravers, printers, inspectors .... experience in toilet paper production is a resume enhancer !
You forgot paper hangers.
Save string !
Channel stuffing fiat to infinity !
boo frickedy hoo for the "traders"
Well, oil prices have in fact collapsed.
Think they want a strong dollar? Think again.
“Bonds are designed to be buy-to-hold, the idea you should have a lot of liquidity is nonsense,” said Scott-Quinn. “One problem we have with the system is not enough capital is patient capital willing to sit out the ups and downs in the market, but instead pays a price for instant liquidity.”
^At least this guy has a future in stand-up comedy.
Decreasing liquidity in the bond markets you say? After a 30 year bull run you say? Get me Yellen on line 1, we need more "patient capital".
Depends on the bond.
Treasuries are one thing...debt markets a whole nother matter.
Treasuries are just risk mitigation in my view. "What to buy in case gold, silver, oil, equities, etc" suddenly drop 40%.
We all know there is still no recovery.
My personal view is "the escape hatch" is war with Russia. Not saying its a good one just saying. "Once the economy is destroyed you follow it up with an actual attack."
That's why I never liked the policy. Is Ukraine better off with the sanctions regime? How about Belorussia?
Good luck putting that genie back in the bottle.
Patient Capital .... the Affordable Care Act !
yeah everythnig is fucked.. the equity markets as well as bond markets are akin to a capcitor which is currently being charged.. and the discharge will be quick, powerful and will destroy many economies of smaller countries (Europe) and likely lead to markets which are heavily regulated and soup lines for past bankers and participants as there will no be any business left to do when the velocity of $$ plunges to zero...
As I said when QE 3 started:
QE will kill Wall street.
prediction fulfilled
Who needs taxes, stocks, bonds, jobs, manufacturing .... QE does it all !
From the limited knowledge I have of Bond traders - the knock on effect to hookers and blow is more important. Seems to me that most of these guys seem to execute trades that just go through some old boy system where the only reason one trader is used over another is his debauchery level and expense account limit.
Then again - I'm just an outsider looking in. Maybe they are all Ivy League geniuses and should be Masters of the Universe. (OK - no I don't believe that - I really want to see them try and survive in a SHTF scenario. God I'm shallow.)
Who bought the $2,500,000,000.00 in Dominican republic bonds issued 3 weeks ago?
Nobody knowingly.