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Liquidity Pinched on Corporate Block Trades, JPMorgan Says

Banks and money managers are having a tougher time trading corporate bonds in large sizes and older issues as Europe’s sovereign debt crisis limits risk-taking, according to JPMorgan Chase & Co. strategists.

The proportion of transactions in the investment-grade bond market that are larger than $5 million, known as block trades, has dropped to 43 percent from as high as 54 percent in 2011, JPMorgan credit strategist led by Eric Beinstein in New York wrote in a note to investors today. Buying and selling has become concentrated in so-called on-the-run bonds, which typically are recent issues, while relative trading in non-financial company debt is at a record low, compared to financial debentures, the analysts said.

The report illustrates where liquidity in credit markets has evaporated most as a JPMorgan survey of investors this month showed all respondents were concerned with the ease at which they can trade. While such corners of the market have been impacted, overall volumes have remained stable, they said, even as dealers reduced their inventories to an eight-year low.

“Liquidity is people’s ability to get done what they want to get done,” Beinstein said in a telephone interview. “If you’re trying to trade off-the-run bonds now, that’s a little bit harder. If you’re trying to trade larger blocks, the data suggests that’s harder as well.”

Block Trading

The proportion of trading completed in blocks of $5 million or larger reached as low as 41 percent at the end of September. Trading volumes in the top 20 percent of investment-grade corporate bonds have climbed to levels on par with those during the months before the 2008 credit crisis, the strategists wrote in the note.

“The more concentrated the trading, the less breadth there is to liquidity,” the New York-based analysts said.

The amount of buying and selling in non-financial company debt, which makes up two thirds of the investment-grade bond market, has shrunk relative to trading in bonds of banks and other financial companies, the analysts said.

A measure of trading in non-financial debt relative to the amount of debt outstanding has dropped to 0.17 percent, compared with 0.23 percent for financial debt. The gap “has never been this large and this long-lasting,” the strategists said.

Investor perceptions of liquidity have deteriorated as banks globally face increased capital requirements and potential losses from debt-laden European nations including Greece, Portugal and Ireland.

Dealer Inventories

Bondholders will need to take deeper losses on Greek government bonds to make the country’s debt sustainable, according to a report dated today on the nation’s finances by international creditors.

Federal Reserve data showed that dealer inventories of corporate bonds dropped to the lowest since July 2003 the week ended Oct. 5. The 22 primary dealers of U.S. government securities that trade directly with the Fed reduced inventories of corporate debt due in more than a year to $54.6 billion, down 42 percent since May. The level climbed to $55.5 billion in the week ended Oct. 12, Fed data show.

While the drop in inventories and overall limits in risk-taking by investors is likely impairing liquidity in pockets of the market such as block trades, overall trading volumes have increased this year, the JPMorgan analysts said.

“Trading volumes are actually pretty stable, even though it’s true that dealers have smaller positions than they had previously,” Beinstein said in the interview. “It’s a little more subtle than the general perception.”

The gap between where dealers will buy and sell securities also has widened, although the analysts said that’s because of the higher relative yields at which bonds are trading.

The average bid-ask spread has increased to 12 basis points from eight at the start of the year, according to JPMorgan.

“The proportion of bid/ask spread to the overall level of spreads is slightly down, meaning that nothing has changed structurally,” they wrote. “Merely, more bonds are trading at wider levels than before.”

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