Corporate Bond Conundrum: A Riddle, Wrapped in a Mystery, Inside an Enigma

Fixed income institutional investors are anxious – worried about the state of liquidity provision. Liquidity in the U.S. corporate bond market has dissipated since the financial crisis, and it has not yet recovered. The headline narrative leads us to believe the responsibility lies with the dealing community, which has withdrawn balance sheet commitment and reduced inventories by more than 75%.

Seismic shifts in regulation are forcing dealers to alter their business models. As a consequence, the availability of on-demand liquidity provision is changing and/or becoming more expensive. As the market grows unabated, dealer balance sheets are dwarfed by AUM, and the impact of their liquidity provision is attenuated. Increasingly, this emerging imbalance is impacting liquidity.

In the end, the data is misleading and liquidity is fractured at best. The singular dependence the market has on the principal-based model exacerbates the problem, creating a potentially untenable position for market participants should a new crisis erupt. A new structure is warranted, one that utilizes technology to bring the marketplace together more efficiently so that new sources of liquidity can be uncovered and new avenues of risk transfer traversed.

TABB Group Director of Fixed Income Research Anthony Perrotta explores the growing structural imbalance plaguing the corporate bond market, highlighting the inconsistencies in both the narrative and the data in an attempt to understand the corporate bond conundrum.