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Just a few weeks in the past, Apollo’s chief economist Torsten Sløk despatched round a chart displaying how liquidity for “off-the-run” company bonds was the worst since March 2020. Pimco has now provided up an indirect riposte.
OK, Pimco‘s report insisting that there was “no vital stress in public credit score market liquidity” was truly revealed final week, however on the time we had been distracted. On the precept that it’s by no means too late to write down about oblique passive-aggressive credit score supervisor spats, let’s have a look.
The central level made by Mohit Mittal — Pimco’s chief funding officer for core methods — is that this can be a nice time to purchase bonds. Sure, we’re shocked too.
However the report does embrace a number of good charts displaying the bid-ask unfold on US funding grade company debt rising however remaining beneath its longer-term common . . .
. . . and buying and selling volumes going via the roof.
Final month’s Sløkchart goes completely unmentioned, however it’s laborious to not learn that is as an oblique retort to Sløk saying that “off-the-run paper has change into nearly untradeable”. As Mittal writes:
Latest Treasury sell-offs have sparked untimely and unwarranted considerations about public fastened revenue valuations and liquidity, significantly in public credit score. Regardless of the volatility induced by current tariff bulletins, bond liquidity stays sturdy, with no materials indicators of stress in public IG credit score. As is typical in periods of heightened volatility, public credit score (IG) bid-ask spreads have widened — a development that has traditionally, at instances, indicated a tougher setting for liquidity. Nonetheless, present spreads stay properly inside their longterm common vary and are beneath the peaks seen throughout 2022’s volatility.
Alphaville acquired a good few emails from credit score traders calling Apollo’s analysis baloney (some had been ruder than that), however there is a vital distinction right here that Pimco doesn’t actually tackle.
Apollo’s chart particularly checked out bid-ask spreads on sub-$900mn bonds issued no less than two years in the past, ie barely stale, less-traded “off-the-run” securities. These had been those that Sløk known as “nearly untradeable”, not the liquid half of the US company bond market.
Now, Alphaville has some points with Apollo’s use of seller quotes right here, given how a number of buying and selling these days occurs via numerous platforms. And we merely don’t purchase that off-the-run liquidity has been as dangerous this month because it was in March 2020, when even US Treasuries grew to become illiquid.
However Pimco et al highlighting the resilience of funding grade company debt — each when it comes to liquidity and costs — doesn’t essentially refute the narrower level that off-the-run liquidity appears to have deteriorated significantly sharply. Maybe not March 2020-bad, however it’s actually not been nice.
The query is why. We’ve had a number of ideas since our final speculative submit, and sanity-tested them with a number of good credit score folks. That is largely a principle — and is likely to be a case of hammers seeing nails in every single place — however it’s in all probability associated to the expansion of bond ETFs.
As a senior trade determine advised us for a chunky Alphaville post on the subject last year:
The underlying bond market has change into virtually like a two-way speedway. Bonds which are on these investible lists are more and more liquid, as a result of you’ll be able to create them into an ETF or break the ETF aside and take them again. However bonds that aren’t on these investible lists have change into extra illiquid.
Principally, the creation-redemption know-how that underpins ETFs and the ensuing increase in portfolio and electronic buying and selling have made the liquid bits of the company bond market much more liquid, even at instances of stress. Nonetheless, bonds which are much less liquid — and thus aren’t in as many bond indices, bond ETFs or bond portfolios — change into much less liquid each in relative and absolute phrases.
In different phrases, all that additional exercise within the more healthy nook of the credit score market truly detracts just a little from the vibrancy of the remainder of the market. And this turns into significantly and more and more stark at aggravating instances, when traders all the time gravitate in direction of extra liquid securities anyway.
Think about a grocery store the place consumers will naturally favour brisker meals, however many can be completely satisfied to snag some bargain-priced steaks or bananas with a number of blotches. Nonetheless, in a well being scare over short-dated meals virtually everybody will need the most effective stuff. ETFs are like a brand new fancy fridge that retains meals wanting much more attractive for longer, however drags consumers away from the discount bin.
OK, that is in all probability a really dangerous metaphor, however hopefully you get the drift. How positive are we that our ETF cannibalisation principle helps clarify Apollo’s findings and the views of Pimco et al? Solely reasonably. Please get in contact when you have a greater principle.
