TABB Group sounds warning on US corporate bond market

Traditional indicators misleadingly suggest that liquidity in the US corporate bond market is currently thriving, but even in the years preceding the 2008 financial crisis these measures were increasingly challenged, suggests TABB Group.

The New York and London-based international research and consulting firm says that traditional liquidity metrics – including volume traded, issuance, notional outstanding and bid/ask spreads – are “as narrow today as they were in pre-crisis years”.

More robust metrics are now needed, according to its report entitled ‘Bond Liquidity Metrics: Reading Between the Lines’, which notes that many regulatory bodies have publicly reinforced an optimistic outlook for the market based only on the traditional liquidity measures.

In the report,  co-authors Anthony Perrotta, TABB partner, global head of research and consulting, and TABB analyst Colby Jenkins, leverage 2015 survey results from asset managers, dealers, and hedge funds to assess the landscape of the US bond market and the effectiveness of tools used by market participants to measure its liquidity.

“Dealer business models have shifted, leaving post-trade data and the established procedures for reporting unable to capture the evolving dynamic, which in turn has misled regulators and market participants relying on traditional trade data resources,” says Perrotta.

“As dealers step back from their role as dependable facilitators of liquidity and providers of pre-trade information, innovative liquidity measurement solutions may step in to fill the gap and become a key tool for investors seeking to navigate tomorrow’s corporate bond market.”

Among the survey findings analysed in the report:

• Notional outstanding in US corporate bonds has more than doubled since 2002 from US$4 trillion to over US$8 trillion from $4 trillion.
• Annual notional volume traded for US corporate bonds in 2015 was US$7.2 trillion, double the figure of US$3.6 trillion in 2008.
• Balance sheet capacity for the 10 largest dealers has declined by 21% since 2007 for US corporate bonds.
• TABB’s liquidity impact ratio for US corporate bonds has decreased by 60% since 2007.
• Since 2009, bid/ask spreads for US corporate bonds have continued to drop, becoming narrow, but masking the hidden liquidity premium of riskless principal transactions.
• Last year 70% of high yield trades over US$2m among dealers was made up by riskless-principal, order-driven trading, up from 20% in 2006.

“Although high-level statistics taken at face value suggest that the notion of a liquidity crisis affecting the marketplace is unfounded, a more in-depth analysis clearly tells a different story,” says Jenkins.

“Looking further into the data, we find that liquidity has decreased precipitously and the changing market structure is eroding the bond market’s status quo.”