Bond trading frenzy threatens to lull market makers into a false sense of security

(Bloomberg) — On the surface, the corporate bond market has never looked so stable and liquid. In the US, the market recorded its busiest month ever in terms of trading volume in September.

But history shows that the ability to trade smoothly is only there until you need it, and the International Monetary Fund warned this week that tight spreads increase the risk of an abrupt repricing of credit.

According to Blair Shwedo, head of fixed income sales and trading at US Bank, trading volume typically increases when investors crave risk. Securities that are relatively easy to sell can also help money managers limit losses and return cash to investors who can redeem when markets sell off.

“My concern is the kind of self-fulfilling prophecy where everyone thinks liquidity is good and getting better,” Shwedo said in an interview Wednesday. “Does that bring us to a point where, because everyone is under the impression that liquidity is really good, the music stops and we see a drastic deterioration?”

Currently, credit spreads show that bond markets are priced for perfection, supported by a robust outlook for the US economy and the likelihood of further policy easing from the Federal Reserve. That makes them more vulnerable to rapid price revisions if volatility increases – as could be the case in the wake of November’s presidential election.

Shwedo sees no 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 a greater ability to bid prices than in 2020, when the pandemic roiled markets, he said.

More and more non-banks are also making markets, with platforms like MarketAxess Holdings Inc. and Tradeweb Markets Inc. are becoming popular because credits are increasingly traded electronically. More users improve liquidity, which further drives orders.

That has made September the biggest month ever for U.S. investment-grade trading, with average daily volume exceeding $43 billion, according to Bloomberg Intelligence. According to data from Coalition Greenwich, electronic activity accounted for 50% of trading in high-quality bonds in September.

Portfolio trading, where investors buy or sell a block of bonds in one or two trades, is now a key driver of smooth trading, according to Barclays Plc. It has grown dramatically in recent years, rising to 25% of dealer-to-customer volume in September, up from virtually 0% in 2018, analysts led by Dominique Toublan wrote in a note last week.

However, the IMF also warned this week that the rise of non-bank financial institutions means that “the availability of market liquidity in times of stress has been called into question.”

Election anxiety

Investors derive a sense of security from the ability to move bonds easily and cheaply, but if the vote count drags, the results are disputed or there are tax surprises, buyers may struggle to find a bid when global markets spin around.

“You never know where these elections will end up. You never know what kind of volatility they can cause,” said Jonny Fine, global head of investment grade debt at Goldman Sachs Group, who spoke about presidential elections in general, not just the US.

According to Bloomberg Intelligence analyst Brian Meehan, all kinds of things can cause a liquidity crisis. Macro data could turn around and undermine belief in the strong economic growth story. Donald Trump could win the election and impose punitive tariffs that accelerate inflation, or more zombie companies could struggle to refinance, he said.

“It looks like a disaster is in the making,” he said in a telephone interview Wednesday.

Weekly overview

Boeing Co. is likely to raise as much as $20 billion in equity to shore up its balance sheet after the troubled aircraft maker reported it expects to burn cash in 2025, a research analyst at Bank of America Corp. said.
Defaults in an opaque corner of China’s local debt market have soared to a record high, trapping investors who assumed the securities had an implicit government guarantee. Failures of so-called non-standard products, which are fixed income investments that are not publicly traded, have risen to record levels.
Investors are piling into European junk bonds at the fastest pace in three years, hoping that interest rate cuts in the region will outpace those in the US.
In the US corporate bond market, prices indicate that the prospects for blue-chip companies are improving. Derivatives traders, however, don’t seem so sure. The difference could be a sign that investors have some doubts about how much corporate bonds have risen versus government bonds in recent weeks.
Procter & Gamble Co. tied its own record for selling a 10-year US corporate bond at the tightest spread against comparable government bonds.
Banks and private credit companies are competing to provide at least $5 billion in debt financing to help finance a potential takeover of Bausch + Lomb.
Chinese regulators are cracking down on misconduct in the world’s second-largest corporate bond market as they seek to reduce financial risk. The country’s securities watchdog said it had suspended Central China Securities Co.’s corporate bond underwriting business. and Kaiyuan Securities Co. has been suspended for six months, according to statements dated October 18.
Companies have borrowed a record $1 trillion in the U.S. leveraged loan market this year, driven by interest rate repricing that lowers the cost of financing the risky debt.
Corporate bond investors are facing losses on debt linked to the failed takeover of Capri Holdings Ltd. by Tapestry Inc., as the former could repay the $4.5 billion it borrowed to finance the deal.
Analysts at Goldman Sachs Group Inc. and BNP Paribas SA predict the end of a rally that has turned the global credit market into a uniform mass of expensive assets. They recommend taking a more defensive stance to widen the gap between safer and riskier debt.
Some Wall Street banks have started reducing exposure to debt from the Apollo Global Management Inc.-owned company. backed Brightspeed, which remained on the balance sheet after a buyout two years ago.
Spirit Airlines Inc. is in discussions with Frontier Group Holdings Inc. on a bankruptcy filing to facilitate a takeover by the rival discount carrier.
Bankrupt hedge fund Weiss Multi-Strategy Advisers LLC and its largest creditor, Jefferies Financial Group, are discussing a possible settlement that would resolve lawsuits related to the collapse of George Weiss’s namesake company.

In motion

Wells Fargo & Co. has recruited Barclays Plc veteran Peter Thomson as managing director in the syndicate unit of the bank’s leveraged finance business.
Barclays said it has hired Anastasia Chernetskaya, a leveraged lending and high-yield bond banker, from Deutsche Bank in London.
Insurance company Pacific Life has hired Richard Talmadge as head of private asset-backed securities.
HSBC Holdings Plc has acquired Lawrence Xu from Goldman Sachs Group Inc. appointed head of European financial credit trading.
Marathon Asset Management is preparing to issue collateralized loan obligations that meet European regulatory requirements, packaging the securities through a newly created investment advisory unit called Bryant Park Funding CLO Management.

–With help from Neil Callanan and Dan Wilchins.