Bond Traders Find Answer to Broken Market: Switch to Currencies

Just because it’s getting harder to trade bonds doesn’t mean that investors are sitting on their hands.

Instead, they’re turning to currencies, which are largely bought and sold electronically rather than through dealers, according to Joyce Chang, the global head of research at JPMorgan Chase & Co. in New York.

The evidence is compelling: Average daily trading in global foreign-exchange markets rose to a record at the end of 2014, while turnover in U.S. Treasuries and investment-grade corporate bonds fell, according to survey measures compiled by JPMorgan.

From BlackRock Inc. to Fidelity Investments, the world’s biggest investors have complained that it’s getting more difficult to transact even though the Bank for International Settlements estimates that the global debt market has swelled to more than $100 trillion. There’s no easy solution as investors pile into seemingly the same bets and new regulations intended to make the financial system safer cause banks to curtail their traditional role in facilitating trades.

So, bond investors are switching to other, more-frequently traded markets to give themselves more flexibility.

“Market liquidity is going to get worse before it gets better as regulatory headwinds remain,” Chang said in a telephone interview. “It’s not just a problem in the riskier credit markets,” but also for top-rated corporates, sovereign and government bonds of developed nations.

Bond Liquidity

A measure of how easy it is to trade in the U.S. Treasury market is approaching the lows reached in the first six months of 2009, when the U.S. was emerging from the worst financial crisis since the Great Depression, according to JPMorgan data. Investment-grade bonds changed hands less often in the last three months of 2014 versus the same period a year earlier, the data show.

While the amount of marketable Treasuries outstanding has almost tripled since 2007 to $12.5 trillion at the end of last year, trading has fallen 11 percent, according to data compiled by the Securities Industry & Financial Markets Association.

In contrast, turnover in global currencies surged at the end of 2014 and has continued increasing in 2015, according to data compiled by JPMorgan that comprised spot trades, forwards, currency swaps, foreign exchange and options in the biggest world markets.

So why does this matter? According to Chang, the next crisis could be prompted by forces that are very different than the mortgage meltdown in 2008. This time, investors will likely suffer losses resulting from volatile markets that are increasingly susceptible to shocks.

Seeking Refuge

A group of bond professionals sponsored by the Federal Reserve Bank of New York expressed concern that the large gyrations seen in the Treasury market on Oct. 15 could be repeated, according to minutes of their meeting released Monday.

Investors are seeking refuge in markets that rely on electronic systems rather than the Wall Street desks that stepped back from trading during the height of the volatility on that day, when yields on 10-year notes fell the most since 2009 in a matter of minutes.

Currencies are a natural alternative given they are closely tied to the same monetary policies that dominate debt markets.

“This is not a traditional credit cycle,” Chang said. “It’s going to be that you have market moves and gaps that feel like the crisis, but the cause of it is very different. It’s because of poor liquidity.”

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