BlueBay Favors Futures as Rout Saps Liquidity in Cash Bonds

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Futures Heatmap

As the tumultuous selloff in euro-area bonds snarled up fixed-income markets this month, futures exchanges emerged as one of the biggest beneficiaries.

Trading in German bund futures on Deutsche Boerse AG’s Eurex surged last week to the greatest volume since 2011, data compiled by Bloomberg show. That’s a turnaround from the previous month, which was the worst April for turnover in at least 10 years. Italian and French bond futures trading reached record highs.

Investors pounced on the derivatives because they offered deeper market liquidity amid a shortage of regular bonds to trade. Turnover in bund futures peaked on May 7, when a widening spread between the best bids and offers for the cash bonds helped exaggerate a selloff that pushed yields up by the most intraday since August 2012.

“I’ve certainly observed an increasing differential in terms of liquidity between liquid derivatives and off-the-run cash securities,” said Mark Dowding, a London-based partner and money manager at BlueBay Asset Management LLP. “We’ve made use of liquid derivatives and we’ll continue to do so.”

Trading in 10-year bund futures reached 5.87 million contracts last week, the most since July 2011, data compiled by Bloomberg show. The number of outstanding positions -- known as open interest -- on the front contract reached 1.48 million, the highest since 2007.

Dealing in Italian futures surged to 779,379 contracts, the most since Bloomberg started gathering the data in 2009. French futures volume reached almost 700,000 contracts, almost double that of the week before.

Bond Rout

“The fact that the amount of futures trading has been so much larger than in cash bonds suggests liquidity in the cash market has been poor and investors have had no choice but to seek alternatives,” said Carl Norrey, co-head of rates trading for Europe, Middle East and Africa at JPMorgan Chase & Co. “It’s possible that as the market turned down, the momentum was negative and CTAs became sellers.”

CTAs, or Commodity Trading Advisors, are funds that normally use futures contracts for trading and investment.

Bonds tumbled across Europe over the past three weeks as investors unwound bets prices would rise amid data suggesting the risk of deflation had subsided. The global selloff was the worst in two years and wiped more than $400 billion from markets worldwide.

Diminishing Liquidity

Diminishing liquidity in the regular -- or cash -- bond market led to price gyrations as investors rushed for the exits. The bid-offer spread for German 10-year bonds, a gauge of the market’s depth derived from the difference in yields between buyers and sellers, widened to 0.27 basis point last week, up from as low as 0.1 in March and an average of 0.2 this year, data compiled by Bloomberg show.

As the region’s benchmark sovereign securities, those 10-year bunds are among the most liquid euro-denominated government bonds.

That’s made derivatives more popular. The contracts are based on underlying assets and can provide the same exposure without tying up as much capital. The boost to this market reflects an unintended consequence of central banks’ bond-buying plans, which have reduced the amount of debt in circulation.

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