Conference Presentation, Panel
Trick of the Trade: Pouring Liquidity Back Into Fixed Income
Milken InstituteLarry Tabb, Konstantinos Antiochus, Michael Frino, Amy Koch, Fred Orlin, Michael Puar, Mike McCurry, Kathryn Hartmann, David Rockefeller Jr.
- Outstanding corporate bonds are projected to continue rising with issuance having nearly doubled over the past 13 years, while dealer balance sheets are expected to remain approximately 20% to 21% below 2007 levels due to deleveraging.
- Market structure is shifting away from traditional principal positioning toward riskless agency models, a transition driven by regulatory capital requirements like Basel III which raised financing costs, reduced dealer hedge fund liquidity providers, and diminished CDS market utility, though traders may resume risk-taking if profitability improves.
- Concerns regarding future liquidity mirrors the 2008 financial crisis stem from mutual funds and ETFs acting as indiscriminate buyers and sellers, creating tail risks if investor sentiment shifts, while specific sectors face varying liquidity levels.
- Low interest rates and a flat yield curve have created a surplus of capital with limited investment opportunities, whereas a normal yield curve and higher rates could potentially refresh dealer balance sheets.
- Regulatory frameworks including Dodd-Frank have altered the landscape by increasing capital holds and reducing hedging capabilities, with future adjustments expected to be embedded in must-pass bills rather than standalone technical corrections.
- Post-trade transparency via TRACE improved liquidity for retail investors without detrimental effects, though excessive transparency risks driving activity to dark pools, necessitating an optimal level of disclosure.
- Delayed reporting for large blocks is preferred by some market participants to facilitate trade exits over longer timeframes, while standardization efforts are anticipated to require five to ten years to materially impact liquidity due to the volume of nonstandardized issues.
- Electronic trading is viewed as a necessary evolution to connect buyers and sellers during stress when dealers cannot take risk, yet adoption faces hurdles due to buy-side resistance to change, settlement mismatches, and the need for passive liquidity solutions over active order books.
- Asset managers are adapting through stress testing, counterparty default mocks, and liquidity analysis to protect investors, while also managing cash holdings to preserve returns amidst the evolving execution landscape.
- The market faces ongoing volatility risks, highlighted by the October treasury market flash crash, prompting the Treasury Department's concern and a need for platforms to demonstrate viability through proving winners and losers.