Liquidity will be at a premium if steep bond market sell-offs resume
New trading protocols offer some hope that investors may find the other side of the trade, but turnover in normally liquid bonds can suddenly collapse.
Investment banking revenues have been sustained by high volumes of fixed income market trading in recent quarters, even as bond prices fell. But the quality of those markets has varied alarmingly.
At the worst point in June, debt capital markets bankers pinned the collapse in new issue volumes on the fact that bond funds were suffering outflows and portfolio managers simply would not raise cash – even for attractively priced new issues – if that required selling assets from their portfolios.
Amid rising rates and with credit spreads gapping out, secondary market bid-offer spreads were too wide and the risks too high of executing any sizeable block without pushing prices even further down.
Secondary markets and primary markets both stalled.
Illiquidity in a sell-off is a problem that bond market participants have had over a decade to prepare for. As rate repression and thin credit spreads made debt almost free for high-quality issuers, bond outstandings swelled far beyond the capital capacity of bank trading desks to intermediate.
Now, even as rates markets stabilize – because bond investors believe that the coming recession will slow the aggressive pace of central bank hiking to contain inflation – worries continue to mount in the credit markets.