Bloomberg News

Liquidity Drought Allayed in Fed-Fueled Trading: Credit Markets

November 05, 2013

Philip Morris International Inc. Cigarettes

Philip Morris International Inc., the world’s largest publicly traded tobacco company, raised $2 billion selling bonds in its second U.S. offering this year. Photographer: Daniel Acker/Bloomberg

Corporate bond trading volumes are surging the most since 2008 as buyers wager they’ll be able to reap more gains before the Federal Reserve starts tapering stimulus that’s fueled a record rally in the debt.

Average daily trading of investment- and speculative-grade debt surged to $19.5 billion in October, up 18 percent from the previous 90-day period, according to Trace (NTMBIV), the bond reporting system of the Financial Industry Regulatory Authority. The Bloomberg USD High Yield Corporate Bond Index (BUHY) gained 2.3 percent last month, the most since January 2012.

“The sentiment in the market has improved a bit because there’s more confidence that the Fed isn’t going to allow rates to shoot up anytime soon,” said David Breazzano, president of Waltham, Massachusetts-based DDJ Capital Management LLC, which oversees more than $6 billion in speculative-grade assets. “There’s no doubt in my mind that the credit cycle is still alive and well and we are going to have a correction.”

While it’s getting easier to trade bonds as sentiment improves, liquidity tends to disappear when needed most, according to a July report by the U.S. Treasury’s Borrowing Advisory committee. Trading declined 14 percent in the second quarter from the first three months of 2013 as speculation mounted that the Fed would begin trimming $85 billion of monthly debt purchases that’s helped propel a 66.3 percent gain in company debentures since the end of 2008.

‘Punitive Cost’

The central bank will maintain the pace of its stimulus through March after a partial shutdown of the federal government in October weakened the world’s largest economy, according to the median estimate of 40 economists surveyed by Bloomberg News.

“There’s just an expectation that if you stay on the sidelines as an investor it’s a very punitive cost,” said Thomas Chow, a Philadelphia-based money manager at Delaware Investments who helps oversee about $135 billion, said in a telephone interview. “Corporates are a good risk right now relative to other opportunities in the market.”

Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. increased, with the Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, adding 1.5 basis points to a mid-price of 74.7 basis points as of 10:29 a.m. in New York, according to prices compiled by Bloomberg.

Financial Conditions

The measure typically rises as investor confidence deteriorates and falls as it improves. Credit-default 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.

A gauge of the health of U.S. financial conditions rose to a record. The Bloomberg U.S. Financial Conditions Index, which combines everything from money-market rates to yields on government and corporate bonds to volatility in equities, increased 0.03 to 1.67. That’s the highest level for the gauge in data dating back to January 1994.

Bonds of AT&T Inc. (T:US) are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 6.4 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The Dallas-based telephone company said it plans to borrow in euros to help fund a tender offer that may exceed $4 billion.

Trading Surge

High-yield bonds are leading the surge in trading, with an average daily volume of $6.18 billion in October, up 27 percent from $4.87 billion in the three months ended Sept. 30, Trace data show. Speculative-grade securities are rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s.

Investment-grade volumes increased 15 percent to $13.33 billion from $11.59 billion.

That’s a reversal from the third quarter, when volumes plunged 14 percent to $16.5 billion on average from the first half of the year as concern grew that the Fed would start tapering quantitative easing as soon as its September meeting.

In October 2008, the month after the failure of Lehman Brothers Holdings Inc., corporate-debt trading rose to $13.39 billion on average each day from $10.1 billion in the prior 90-day period, Trace data show. That month, the Bank of America Merrill Lynch U.S. Corporate & High Yield Index dropped 9.2 percent, the worst monthly loss on record.

Fed Chairman Ben S. Bernanke rattled fixed-income markets on May 22 by telling Congress that the central bank may reduce the pace of its purchases of Treasuries and mortgage bonds if the economy showed sustained improvement.

Bank Revenue

The Bank of America Merrill Lynch U.S. Corporate & High Yield Index plunged 3 percent in the three months ended June 30, the biggest quarterly loss since 2008.

The five biggest U.S. investment banks saw their combined revenue from fixed-income, currencies and commodities trading drop 25 percent in the third quarter from a year earlier, according to Bloomberg Industries data.

The selloff “was not a call on the fundamentals,” said Chow of Delaware Investments. “There are a good amount of opportunities from fundamentally strong companies that continue to be cautious with their cash balances.”

Yields on the dollar-denominated debentures rose to an almost 15-month high of 4.37 percent on Sept. 5 from the record low of 3.35 percent on May 2, Bank of America Merrill Lynch index data show. Yields have since fallen to 3.93 percent as of yesterday.

Corporate-bond funds reported $6.8 billion of deposits in October, after hemorrhaging $13.6 billion in June, according to data compiled by Royal Bank of Scotland Group Plc. (RBS)

Trading ‘Frenzy’

“You’ve seen a frenzy of activity to try to put money to work,” said Jason Rosiak, head of portfolio management at Newport Beach, California-based Pacific Asset Management, the Pacific Life Insurance Co. affiliate that oversees $4.3 billion in corporate credit. As new debt sales fail to satiate demand from fund managers who are receiving inflows, “they’re being driven to the secondary market.”

Companies sold $129.6 billion of bonds in the U.S. in October, down from $219.5 billion in September, Bloomberg data show. They’ve raced to take advantage of below-average yields this year, with total issuance reaching $1.38 trillion, 5 percent more than in the corresponding period last year, the data show.

Expanding Market

While trading has surged more this October than in similar periods during the previous four years, volumes have been unable to keep pace with a U.S. corporate-bond market that’s expanded 72 percent since the end of 2008, to $5.54 trillion from $3.22 trillion, Bank of America Merrill Lynch index data show.

As a result, there’s “potential for significant dislocation when investor flows reverse,” according to a presentation for the the Treasury advisory committee’s report in July.

The Fed could maintain the pace of its stimulus even as the job market improves, said James Bullard, president of the Fed Bank of St. Louis yesterday. The number of Americans filing jobless claims decreased by 10,000 to 340,000 in the week ended Oct. 26, compared with an average 330,000 a week in August, according to the Labor Department.

“We’re more conservative than we often are because we’re not being paid to do otherwise,” Breazzano said. “You’re not getting paid to take a lot of risk anymore.”

To contact the reporter on this story: Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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