(Bloomberg) - On the surface, the corporate bond market has never looked more stable and liquid. In the US, the market recorded its busiest month ever for trading volume in September.
But history suggests that the ability to trade smoothly is only there until you need it, and the International Monetary Fund warned this week that tight spreads are raising the risk of an abrupt repricing of credit.
Typically, the volume of trades rises when investors crave risk, according to Blair Shwedo, head of fixed income sales and trading at U.S. Bank. Securities that are relatively easy to sell can also help money managers limit losses and return cash to investors redeeming when markets sell off.
“My concern is the kind of self-fulfilling prophecy of everybody thinking liquidity is good and getting better,” said Shwedo in an interview Wednesday. “Does that lead us to a point where, because everybody’s under the assumption that liquidity is really good, the music stops and we see a drastic deterioration?”
At the moment, credit spreads show bond markets priced for perfection, buoyed by a robust outlook for the US economy and the likelihood of more policy easing from the Federal Reserve. That makes them more vulnerable to swift repricing if volatility spikes — as it could in the aftermath of November’s presidential election.
Shwedo does not see any immediate signs of a deterioration in liquidity, barring an exogenous shock. The rise of e-trading, portfolio trades and exchange-traded credit funds gives dealers greater ability to provide pricing than they had in 2020 when the pandemic roiled markets, he said.
More non-banks also make markets, with platforms like MarketAxess Holdings Inc. and Tradeweb Markets Inc. becoming popular as credit is increasingly traded electronically. More users enhances liquidity, which further boosts orders.
That helped September become the biggest month ever for US investment-grade trading, with an average daily volume exceeding $43 billion, according to Bloomberg Intelligence. Electronic activity accounted for 50% of high-grade bond trading in September, based on Coalition Greenwich data.
Portfolio trading, where investors buy or sell a block of bonds in one or two transactions, are now a key driver of the ability to trade smoothly, according to Barclays Plc. It’s boomed in the last few years, rising to 25% of dealer-to-client volumes in September from virtually 0% in 2018, analysts led by Dominique Toublan wrote in a note last week.
The IMF, however, also warned this week that the rise of nonbank financial institutions means “the availability of market liquidity in times of stress has come into question.”
Election Anxiety
Investors derive a sense of security from being able to easily and cheaply move bonds, but if vote counts drag on, results are contested or there are fiscal surprises then buyers could struggle to find a bid when global markets gyrate.
“You never know where these elections are going to end up. You never know what kind of volatility they might introduce,” said Jonny Fine, global head of investment grade debt at Goldman Sachs Group, who was speaking of presidential votes in general, not just the US.
Any number of things could cause a liquidity crunch, according to Bloomberg Intelligence analyst Brian Meehan. Macro data could turn, undermining faith in the strong economic growth narrative, Donald Trump could win the election and enact punitive tariffs that accelerate inflation, or more zombie companies could struggle to refinance, he said.
“It just looks like a disaster in the making,” he said in a phone interview Wednesday.
By Caleb Mutua
With assistance from Neil Callanan and Dan Wilchins
