There’s nothing like a little complacency to make an already precarious situation even more precarious and if IG volumes are any indication, bond traders are getting mighty bored. As a reminder, the current environment in corporate credit — which Gundlach deputy Bonnie Baha recently described [14] as offering one of the “most unattractive risk/return propositions” she’s ever seen — doesn’t offer much in the way of opportunities as central banks have succeeded in herding so many yield-starved investors into IG and HY (i.e. away from government debt which in the best case yields you nothing and in the worst case will guarantee you a loss) that spreads are pitiably low.
Meanwhile, the new regulatory regime has done an admirable job of making the system “safer” by encouraging dealers to shrink their inventories, meaning that while we’re all safe from evil prop traders (because we’re sure prop trading is dead and the Goldmans of the world didn’t find a way around Volcker the very instant it was proposed), secondary market liquidity has evaporated, meaning the door to the proverbial crowded theater is getting smaller even as the number of yield seekers inside is getting larger so when someone finally yells fire, well, let’s mix our metaphors here and say we’re all up a creek.
Given the above, it’s not terribly surprising that bond traders have, in Barclays’ words, made “Monday the new Friday.” Here’s more (from a Friday note):
Activity in credit was muted this week. Investors were slow to return to trading from the Easter holiday, and volumes were sharply lower in the first part of the week. A slow start to the week has become customary, as Monday appears to have become the new Friday. According to year-to-date TRACE data, average investment grade volumes are the same on the first and last days of the week, and Friday volumes are actually 20% higher than Monday volumes for high yield. But the first three days of this week were extreme even in that context, as investment grade volumes were 21% lower than the year-to-date average for the first three days of the week and high yield experienced a 15% drop.
[15]
So basically, no one is trading, so why show up?
And here’s more via Bloomberg [16]:
Barclays says its analysts aren’t suggesting that traders aren’t coming to work or should work fewer days, but highlighting a problem that’s creating a lot of angst in credit markets.
Trading has generally been falling, and in some ways it reveals how the prolonged zero-rate environment is creating malaise from company boardrooms to trading floors. There aren’t real bargains to be had, there doesn’t appear to be a real imminent threat of runaway inflation, and -- aside from oil companies -- it doesn’t really look like corporate America is about to fall apart.
In other words, there isn’t a massive catalyst to prod investors into action.
While the humans are now taking four-day weekends, the robots do not rest and, as we showed earlier today [17], they have (in conjunction with the Fed) commandeered the entire Treasury market where liquidity has fallen to financial crisis lows according to Deutsche Bank. What this means (as Jamie Dimon will also tell you [18]) is that events like last October’s Treasury flash crash are likely to occur more frequently going forward and when you combine the rise of the machines with shrinking dealer inventories and throw in the possibility that the dealers aren’t even coming to work anymore, you paint a rather disturbing (if hilarious in a surreal kind of way) picture of a market that’s been stripped of the human element and now runs on malfunctioning algos which are themselves slaves to Fed doublespeak and Tesla rumors [19].
It’s no wonder then that good people like Matthew Duch at Calvert Investments are hesitant to buy more of the high yield bonds that have been “shoved down their throats” by the Fed. Here’s Bloomberg [20] again:
Calvert Investments money manager Matthew Duch said the mystery of the flash rally leaves him in a tough spot. He wants to buy more high-yield bonds, but said he’s worried about the possibility that a Treasury-market swing could spark broader volatility, making it tough to trade the speculative-grade debt.
Essentially, Matthew is worried that no one is home at bond desks and thinks that may be a very bad thing when (not “if”) the machines decide one day that some random data point or unduly hawkish/dovish soundbite out of an FOMC voter is cause for all the algos to chase down the same rabbit hole sending ripples through a fixed income market devoid of any real liquidity. His concerns are certainly not unfounded and indeed, when it comes to HY, the problem is even more acute. Here’s Barclays:
Within credit, high yield stands out due to its heavy retail ownership and correspondingly high demand for daily liquidity. The challenge of catering to these outsized liquidity needs is compounded by the fact that the high yield buyer base lacks an obvious source of liquidity in volatile times, something akin to the role played by insurance portfolios for investment grade credit and CLOs for loans.
So while it's "pretty quiet out there" now save for the hum of the machines, expect it to get a lot louder on the Tuesday morning when the humans return to their desks and find out everything collapsed on Monday.
