Photographer: Eric Thayer/Getty Images

This Chart Helps Explain the Bond Market Liquidity Story

There's very little incentive to trade.

While investors, traders and analysts often point to new financial regulation as one explanation for the lack of liquidity in the corporate bond market, there is an arguably more salient explanation for the trend.

Years of low interest rates have sparked an intense scrum for bonds. Hearty investor demand has helped propel the primary market in which companies sell their debt, from $5.4 trillion at the end of 2008 to almost $8 trillion now. (That's just in the U.S.)

Low interest rates and buoyant demand effectively squeeze the returns investors can make, known as "carry" in bond market parlance. With the way bonds change hands still stubbornly resisting change, the cost of trading hasn't come down enough to offset that slumping carry, making it more expensive for investors to buy and sell debt.

The chart below, from Citigroup's Hanz Lorenzen, shows the number of months it takes for carry to make up for the (relatively measly) 5 basis points an investor might pay to strike a bond trade. It's gone up, from less than a month in 2009 to about a month and a half now, after falling from a peak of three months last year.

Source: Citigroup

In other words, there's little incentive to trade bonds when investors clutch debt so tightly to their chests (or portfolios) and the returns on offer from doing so don't outweigh the costs. (The exception to this trend is the dealing in brand-new bonds; investors who are lucky enough to get a slice of new debt issues can turn around and sell them into the market for hefty profits.)

Thanks to the Federal Reserve's recent decision to keep interest rates lower for longer, the bond market can "carry" on like this for much longer.

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