The topic of collapsing bond market liquidity (and in many cases, volume) is not new: it has been covered here for over 3 years [16], 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 [17]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 [18], 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 [19], "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 [20]", 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 [21], will be major source of stock buying in the S&P 500 now!
[22]
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.
