Trading in Junk Bonds Declines Most Since 2008: Credit Markets

Junk-bond trading in the U.S. has fallen the most since 2008 as the Federal Reserve keeps investors guessing on when it will slow bond purchases that bolstered demand for the debt.

Daily transactions in speculative-grade notes have averaged $4.87 billion since June 30, 18.1 percent less than volumes in the first half of the year and the biggest drop-off since the credit crisis five years ago, according to data from Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Investment-grade trading, which has been supported by Verizon Communications Inc.’s record $49 billion sale last month, is down 13.6 percent during the same period.

High-yield bond investors are showing greater restraint than in the first half, when yields plunged to the lowest on record and buyers demanded the least compensation relative to Treasuries since October 2007. Trading in the third quarter appeared to have been “turning into a full-scale rout” Sanford C. Bernstein & Co. analyst Brad Hintz wrote in a Sept. 27 note, cutting the earnings estimates of dealers Goldman Sachs Group Inc. and Morgan Stanley.

Reluctant Sellers

“There’s still a level of uncertainty out there that keeps people from having that extra level of conviction that they would have,” Brian Kennedy, a portfolio manager at Loomis Sayles & Co., which had $188 billion of assets under management as of June 30, said in a telephone interview. “It’s hard for us to imagine that we’d have a real pickup in volume” through year-end.

Fixed-income trading volumes may have declined 20 percent to 25 percent on average in the three months ended Sept. 30, according to Hintz. Investors are reluctant to sell their debt holdings unless something fundamentally changes with the corporate borrower, because it may be difficult to repurchase the notes in the future, said Citigroup Inc. strategist Stephen Antczak.

It’s getting harder to quickly maneuver in the company-debt market, he said, with Wall Street’s biggest banks paring holdings in the face of higher capital requirements set by the 27-nation Basel Committee on Banking Supervision and risk-curbing rules laid out by the U.S. Dodd-Frank Act.

Awaiting Evidence

Trading volumes have plunged 19 percent since the three months ended June 30, when $6 billion of high-yield bonds exchanged hands on average each day, Trace data show. Speculative-grade securities are rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s.

The debt posted a 1.4 percent decline in the period, its biggest quarterly loss since 2011, as economists forecast the Federal Open Market Committee would reduce monthly Treasury purchases by $5 billion, to $40 billion, while maintaining its buying of mortgage-backed securities at $40 billion, according to a Bloomberg News survey.

The bonds have reversed the losses in the third quarter, gaining 2.4 percent as the Fed said in a Sept. 18 statement that it “decided to await more evidence that progress will be sustained before adjusting the pace of its purchases.”

“For the first six months of the year people were buying everything,” said Brian Biskupiak, senior trader and portfolio manager at Hartford Investment Management Co., which oversaw $118.1 billion as of June 30. “That’s why trading volumes were high. People were complacent.”

Credit Benchmarks

Elsewhere in credit markets, IntercontinentalExchange Inc., the energy and commodity futures bourse that agreed to buy NYSE Euronext for $8.2 billion, plans to sell $1.2 billion of bonds to help finance the acquisition. The cost to protect against losses on U.S. corporate bonds fell as investors speculated the economic effects of the partial government shutdown will be limited.

The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, fell 1.7 basis points to 80.2 basis points as of 12:06 p.m. in New York, according to prices compiled by Bloomberg.

Congress’s failure to pass a budget partially closed the U.S. government for the first time in 17 years, idling as many as 800,000 federal employees and setting the stage for a debate on raising the nation’s debt ceiling within three weeks.

European Index

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings dropped 5 basis points to 98.9 basis points.

Both indexes typically decline as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

The U.S. two-year interest-rate swap spread, a measure of debt-market stress, fell 0.56 basis point to 13.5 basis points. The gauge typically narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.

Bonds of Verizon Communications Inc. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 8.8 percent of the volume of dealer trades of $1 million or more, Trace data show.

ICE Offering

IntercontinentalExchange Group intends to issue five- and 10-year notes that may be redeemed at 101 cents on the dollar if the purchase isn’t completed by March 31, according to a person with knowledge of the transaction who asked not to be identified because terms aren’t set.

The company will buy back $400 million of privately placed notes by issuing an equal amount of commercial paper immediately after the deal is completed, Standard & Poor’s said in a statement today that estimated the offering size.

The bond sale would be the company’s first since 2011, when it issued the debt it plans to buy back in equal $200 million portions of 4.13 percent notes due November 2018 and 4.69 percent securities maturing 2021, according to data compiled by Bloomberg.

Trading volumes are falling as the 21 primary dealers that do business with the Fed reduce their junk-bond holdings to a net $6.6 billion on Sept. 18 from $7.43 billion on April 3, when the central bank changed the way it reported the data. Inventories of a broader category of corporate debt fell 76 percent from the peak reached in October 2007 through the end of March, the data show.

Crowded Positions

“It’s not like there’s a bank prop desk willing to take the other side of the trade,” said Antczak, Citigroup’s head of U.S. credit strategy in New York. “If you do have a crowded position and a lack of trading, that’s where you could really see some turmoil.”

The $3.86 billion of average daily junk-bond trading in August was the lowest monthly volume of the year, Finra data show. It compares with $6.5 billion of daily transactions in January and about $6 billion on average in the first half of the year. Junk-bond yields plunged to an all-time low of 5.98 percent on May 9 and spreads fell to 423 basis points, according to the Bank of America Merrill Lynch U.S. High Yield Index.

Fed Chairman Ben S. Bernanke said policy makers are “somewhat concerned” by tightening financial conditions and continued their current level of asset purchases as a “precautionary step.”

“To the extent our policy decision today makes conditions just a little bit easier, that’s desirable,” Bernanke said at a Sept. 18 news conference.

Spreads Widen

As concern mounted that the Fed would taper its bond purchases, relative yields widened to an almost six-month high of 534 basis points on June 24 from 423 on May 9, the lowest since October 2007. Spreads have since contracted to 475 basis points as of Sept. 27.

“As an investment manager, I trade when I have something to do,” said Andrew Feltus, a money manager who helps oversee about $37 billion in U.S. fixed-income assets at Pioneer Investment Management Inc. in Boston. “As long as the fundamentals don’t change, there’s a difference between volatility and being wrong.”

The 12-month trailing speculative-grade default rate in the U.S. fell to 2.8 percent in August, down from 2.9 percent in July and 3.6 percent in August 2012, according to Moody’s.

Investment-grade volumes of $11.57 billion since the end of June have been bolstered by $304.1 billion of sales of the dollar-denominated debt in the third quarter, the most since the $314.5 billion of offerings in the first three months of 2013, Bloomberg data show.

Dealer Earnings

Verizon’s eight-part offering on Sept. 11 was almost triple the previous record of $17 billion that Apple Inc. set in April, Bloomberg data show. The sale included $15 billion of 6.55 percent, 30-year securities, the biggest individual corporate bond ever.

The lower trading volumes are eating into the expected returns of the biggest financial firms. Hintz cut Goldman Sachs’s third-quarter per-share earnings estimate by 15 percent to $2.62 and lowered Morgan Stanley’s per-share third-quarter estimate 20 percent to 41 cents.

“While the third quarter is typically seasonally soft, Q3 2013 appears to be turning into a full-scale rout in trading as weak activity and limited risk-taking constrained performance,” Hintz wrote in the Sept. 27 note.

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