Here’s the bright side for all the investors who’ve been so worried about banks using less money to facilitate trading in the $8 trillion corporate-bond market: at least Wall Street wasn’t a big seller in this latest rout.
While investors yanked cash from junk-bond mutual funds for five straight weeks, broker-dealers didn’t contribute as much to the exodus because they had already been holding relatively small amounts of the debt in part due to regulations enacted since the financial crisis.
A “silver lining going into this round of outflows was below-average dealer inventories,” Wells Fargo & Co. analysts led by George Bory wrote Thursday. Primary dealers that trade with the Federal Reserve held a net $3.9 billion of high-yield bonds in the week ended Aug. 19, little changed from the week before and about 11 percent below the year-to-date average, they wrote.
To the extent banks were holding riskier corporate debt, some, including Jefferies Group and Goldman Sachs Group Inc., were said to sustain millions of dollars of losses. So it may have been good that Wall Street banks weren’t holding more of the stuff.
After Lehman Brothers Holdings Inc. collapsed in 2008, triggering the worst financial crisis since the Great Depression, regulators drafted rules to reduce the chance that another major bank would suffer the same fate. In response, the world’s biggest financial firms have curbed holdings of corporate debt and derivatives.
While this has lowered risk, it also forced banks to reduce their role making markets, which they traditionally did to both turn a profit and enable clients to quickly transact in opaque, over-the-counter markets. This has led to a lot of hand-wringing over the jumpiness of junk-bond prices.
And those prices have been swinging quite a bit this year, plunging to an average 94.2 cents this month from a high of 100.4 cents on the dollar in April, according to Bank of America Merrill Lynch index data. The debt started losing value earlier in the year than stocks, foreshadowing the global equity rout that eliminated more than $5 trillion in two weeks this month.
The turmoil has stemmed from some profound concerns, not just technical blips. Forecasters have been lowering their expectations for global growth as China showed signs of slowing down. In turn, commodities sold off dramatically, leading investors to question the viability of speculative-grade energy companies that have sold record amounts of debt.
All of this contributed to a painful couple of weeks in global markets. But in high-yield bonds, at least, Wall Street isn’t making matters any worse with a whole lot of selling.