Remember Y2K? That's How Eaton Vance Sees Bond Liquidity Fears

  • Vanguard says dealers have never been much of a cushion
  • BlackRock says a 25-basis point hike will be `yawn' to many

Eaton Vance Corp.’s Payson Swaffield calls it the “new Y2K bug.”

The firm’s chief income investment officer says concerns that the Federal Reserve’s first interest-rate increase since 2006 will herald bond-ageddon are no different than the software problem that many feared would cripple computers and create mass chaos on January 1, 2000.

“There’s been a lot of paralysis from investors about the end of the world,” he said. “Once we get through the first Fed rate hike, there might be a sigh of relief.”

The big worry has been that rising rates will trigger an exodus of investors from a bond market that’s been propped up by easy-money policies for the better part of a decade. Because post-crisis banking rules have left dealers holding smaller inventories -- and so much investor cash has been parked in fixed-income mutual funds and exchange-traded vehicles -- there’s concern that no one will be there to buy when money managers need to sell.

Jamie Dimon, whose JPMorgan Chase & Co. is the world’s biggest underwriter of corporate bonds, said in April that volatility in October was a “warning shot” to investors that the next financial crisis could be exacerbated by a shortage of the securities. Fed Chair Janet Yellen cautioned in May that there could be “very substantial moves in asset prices” should there be a run on funds that buy illiquid securities while promising investors daily liquidity when they want their cash back.

Eaton Vance, which oversees $95 billion in fixed-income assets, is among a group of mutual-fund managers including BlackRock Inc. and Vanguard Group Inc. seeking to soothe their clients’ concerns. The managers point to a number of things they say should mitigate the worries:

Mass Withdrawals Are Rare

Bond funds have suffered net annual outflows of more than $1 billion just four times in the past 25 years. The most recent was in 2013, a year that dollar-denominated bonds lost 2.2 percent in the first annual decline since 1999, Bank of America Merrill Lynch index data show.


Dealers Give Little Cushion

Even when bond dealers had larger inventories of corporate bonds and other debt securities, the holdings only averaged 2 percent of the total market during the past 15 years, said Swaffield. If anything, the smaller dealer inventories are good for the market because --- like money managers -- they could also become forced sellers and push down prices even further, said Greg Davis, head Vanguard’s fixed-income group. “Given the amount of deleveraging on the dealer side with stricter capital controls, that makes for a safer financial system,” he said.

Others Will Buy

Insurers, pension funds and other investment managers that typically buy and hold will be eager to step in to snap up high-quality credit that’s suddenly yielding more because of mutual-fund selling, said Davis, who oversees about $840 billion of bonds at Vanguard. During the so-called taper tantrum in 2013 -- when the Fed first moved to end unprecedented stimulus measures -- New York Life Insurance Co.’s investment arm stepped in to buy both investment-grade and junk-rated corporate bonds, Tom Girard, the head of fixed income investments at the unit said in June.

“There are huge swaths of investors that quite frankly aren’t going to do anything when rates go up,” said Richard Prager, head of global trading at BlackRock, the world’s largest money management firm. “If the Fed goes up 25 basis points it’s a yawn to them.”

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