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Rekenthaler Report: Will Bond Funds Bring a Surprise?
So while broker-dealers were about half the size of the credit mutual fund industry in 2007, according to the quantity of assets they owned, today they’re only about 1/20th of the size. And those broker-dealers are still the only real liquidity providers in the market.
But neither of the two buy-side bond market giants (Blackrock and Pimco) seem to have been able to make such a system work
This is one reason why the two big bond investors arguably pose a systemic risk: if either one of them were to suffer substantial withdrawals, the selling pressure on the market would be so enormous that the entire bond market could pretty much cease to work.
Sovereigns, however, are another story — they need to borrow in size, and they have historically relied on liquidity issues to ensure that they get the cheapest possible rate. (That’s the main reason why US Treasury bonds have the lowest yields in the world, on a swapped-into-dollars basis: it’s all about the liquidity, not the credit risk.) The great bond liquidity drought is arriving at the worst possible moment for G20 sovereigns which are already struggling with unprecedented levels of bonded debt. It’s always liquidity that kills you, not insolvency: it’s the inability to roll over your debts as they come due.
It always starts in the credit markets. The irony:
"Liquidity is drying up across the bond markets. Regulations designed to curtail banks’ leverage have had the unintended consequence of also sharply reducing their ability and willingness to make markets in corporate and even government debt. New regulations on the leverage ratio that will reduce banks’ repo funding books threaten to make matters even worse and to spread the drought from credit markets to rates, the underpinning of all financial markets. Secondary markets are close to a breakdown that will soon imperil the primary markets on which companies and sovereigns depend for funding. All that is masking the decay is the extraordinary actions of central banks.:
One thing that is working in favor of Soverign liquidity (at least for US Treasury bonds) is that Fed can provided the liquidity and prevent a lockup on Treasury bonds. This does not apply for Euro zone countries the sovereign central bank of each country is limited in its ability to provide the liquidity.
King illustrates how the assets of US mutual funds invested in investment grade and high-yield debt have trebled since 2008, from $300 to $900 billion, reflecting investors’ increasingly desperate search for interest income in low-rate environment.
But the infrastructure supporting bond trading has weakened. The banks that act as intermediaries between the bond market’s buyers and sellers have seen their holdings drop from $286 billion to $69 billion—by 76 percent—to levels last seen in 2002.
There’s a dangerous and increasing imbalance in the markets: a rising pile of debt held by funds promising instantaneous liquidity; and a bridge for those seeking to exit their positions that is capable of carrying less and less weight.
Comments
So while broker-dealers were about half the size of the credit mutual fund industry in 2007, according to the quantity of assets they owned, today they’re only about 1/20th of the size. And those broker-dealers are still the only real liquidity providers in the market.
But neither of the two buy-side bond market giants (Blackrock and Pimco) seem to have been able to make such a system work
This is one reason why the two big bond investors arguably pose a systemic risk: if either one of them were to suffer substantial withdrawals, the selling pressure on the market would be so enormous that the entire bond market could pretty much cease to work.
Sovereigns, however, are another story — they need to borrow in size, and they have historically relied on liquidity issues to ensure that they get the cheapest possible rate. (That’s the main reason why US Treasury bonds have the lowest yields in the world, on a swapped-into-dollars basis: it’s all about the liquidity, not the credit risk.) The great bond liquidity drought is arriving at the worst possible moment for G20 sovereigns which are already struggling with unprecedented levels of bonded debt. It’s always liquidity that kills you, not insolvency: it’s the inability to roll over your debts as they come due.
http://blogs.reuters.com/felix-salmon/2013/11/05/when-bonds-dont-trade/
It always starts in the credit markets. The irony:
"Liquidity is drying up across the bond markets. Regulations designed to curtail banks’ leverage have had the unintended consequence of also sharply reducing their ability and willingness to make markets in corporate and even government debt. New regulations on the leverage ratio that will reduce banks’ repo funding books threaten to make matters even worse and to spread the drought from credit markets to rates, the underpinning of all financial markets. Secondary markets are close to a breakdown that will soon imperil the primary markets on which companies and sovereigns depend for funding. All that is masking the decay is the extraordinary actions of central banks.:
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
An unintended consequence of regulations designed to _prevent_ the next crisis.
King illustrates how the assets of US mutual funds invested in investment grade and high-yield debt have trebled since 2008, from $300 to $900 billion, reflecting investors’ increasingly desperate search for interest income in low-rate environment.
But the infrastructure supporting bond trading has weakened. The banks that act as intermediaries between the bond market’s buyers and sellers have seen their holdings drop from $286 billion to $69 billion—by 76 percent—to levels last seen in 2002.
There’s a dangerous and increasing imbalance in the markets: a rising pile of debt held by funds promising instantaneous liquidity; and a bridge for those seeking to exit their positions that is capable of carrying less and less weight.
http://www.indexuniverse.eu/blog/9373-the-looming-bond-fund-crash.html?year=2013&month=11&Itemid=127