U.S. Treasury Sees Bond Liquidity, But Not as We Know It

  • Department sees no ‘broad-based deterioration’ in liquidity
  • Market in transitionary phase as new trading platforms emerge

Debt investors can breathe a sigh of relief and stop fretting about liquidity in the market, according to the U.S. Treasury.

Measures of corporate-bond liquidity -- typically defined as the ability to trade an asset without moving its price -- show all is well, with volumes, sizes and bid-offer spreads similar to or better than historic averages, Jake Liebschutz, director of the capital markets office at the department, wrote in a blog post on the Treasury’s website. Complaints about and predictions of a liquidity crisis are instead the result of an evolution in the bond market, he wrote, alongside Brian Smith, a senior policy adviser in the same office.

“The available evidence, when viewed holistically and in light of recent market trends, does not suggest a broad-based deterioration in liquidity,” they wrote. Rather, “the corporate bond market is undergoing significant changes that are reshaping the nature of trading and liquidity provision.”

The Treasury’s observations echo those of researchers at the Federal Reserve Bank of New York, who said in October that there is “ample liquidity in corporate bond markets.”

Investor Perspective

Investors see it slightly differently, arguing that banks have reduced trading as they limit risk taking to meet post-crisis regulations. Market observers have contended that it’s become increasingly difficult to trade securities in large sizes, to buy and sell notes quickly, and to establish reliable prices in the high-yield and investment-grade bond market.

“I have never seen such illiquidity in off-the-runs,” said Andrew Brenner, the head of international fixed income for National Alliance Capital Markets. Deterioration in the bond market is evident from the number of banks that are cutting back in their bond units amid a slump in trading, Brenner said.

Goldman Sachs Group Inc. in May extended its reductions in fixed-income operations this year to 10 percent. Trading revenues tumbled 37 percent in this year’s first quarter from a year earlier amid market volatility and falling asset values, while revenue from trading bonds, currencies and commodities plunged 47 percent. Morgan Stanley has also announced cuts in its fixed-income operations.

“There’s a reason firms have reduced their footprint in fixed income secondary trading -- no money,” said Brenner. That means “reduced capital and reduced positions and reduced head count, none of which is good for liquidity.”

The Treasury department instead says the growth of electronic trading, the rise of new trading platforms and the shifting role of dealers is changing the face of liquidity.

Liebschutz and Smith say dealers are acting more as agents -- matching buyers and sellers -- than as principals that take the risk onto their own books as part of the transaction. Concurrently, trading platforms are allowing market participants to transact directly with one another while electronic trading is facilitating price discovery.

The Treasury will “continue to monitor conditions” in the corporate bond market, they wrote.

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