The three charts below, which appeared in this morning's
Wall Street Journal
, are still another reminder that the Fed's heedless fueling of the
third financial bubble this century has done enormous damage to the
internals of financial markets. In this case, investors and savers
being brutally punished by ZIRP were herded into bonds funds in a
desperate scramble for yield. Accordingly, bond fund assets soared
from $1.6 trillion at the time of the financial crisis to $4.1
Yet the market's structural liquidity condition has gone in the
opposite direction. Dealer inventories of corporate bonds have
plummeted by nearly 75% from pre-crash levels, meaning that the
ratio of dealer inventories to bond fund assets has virtually been
vaporized. In 2008 that ratio stood at 15%, but presently it is
only 1.5%. Likewise, daily trading volumes have been cut in half
since the crisis.
The implication is no mystery. When the financial markets
eventually succumb to a "risk-off" selling panic, the corporate
bond market will gap down violently. As one astute analyst put
"Everyone is hoping to be first through the exit," said
Matt King, global head of credit strategy at
in London. "By definition, that's not possible."
Stated differently, the Fed's explicit campaign to force grandpa
out of CDs and into corporate bond funds has caused a vast
mis-pricing of liquidity. In a healthy free market, bond fund
yields would carry a significant discount for illiquidity, and
issuers of riskier corporate credits would face far higher yield
spreads vs. the 10-year treasury benchmark.
So once again, the serial bubble machine in the Eccles Building
has generated a huge unnatural market deformation that is
inherently unstable and increasingly fragile. When the break comes,
years worth of "extra" yield will be wiped-out in a traumatic drop
in bond prices caused by a panic at the exit ramp.
As the balance of the
article makes clear, the risk of log-jam at the exit gates is
especially acute in the $1.6 trillion junk bond market. Prior to
last week's initial sell-off, yield spreads had been squeezed to
absurdly low levels-less than 300 basis points on the Merrill
index. Based on the current rate of inflation and historic 4-5%
long-term losses on junk bonds, the spread should be 600 basis
points or more. Indeed, during the last junk bond sell-off in
2008-2009, the yield spread over the treasury benchmark blew-out to
2000 basis points before the Fed's artificial flood of liquidity
put a stop to the carnage.
But today the junk bond market is far larger; trading
liquidity is far thinner; and the Fed has already used up its
trick card-that is, zero interest rates and massive monetization
of the public debt. Accordingly, the carnage at the junk bond
exit ramp is likely to be far more extensive this time around.
More importantly, the punters who harvested gargantuan profits by
buying junk at peak yields in the spring of 2009 may find that
the fire brigade in the Eccles Building is MIA when the next
crash hits bottom.
By Katy Burne at
The Wall Street Journal
A shakeout in the junk-bond market is drawing only
cautious interest from bargain-hunters, underscoring
investor fears that many once-hot securities could prove
hard to sell in an increasingly difficult trading
U.S. funds investing in debt rated below investment
grade lost an average 1.33% last month, according to a
Barclays PLC index, their second-worst monthly performance
since November 2011. In June 2013, after the Federal
Reserve began hinting that it would scale back its monetary
easing, they lost 2.62%.
The latest junk-bond decline intensified last week as
investors continued to make heavy withdrawals of money,
in part because of worry that a recharged U.S. economy
could prompt the Fed to raise interest rates sooner than
expected, a move that would likely pressure bond
Reflecting the cautious mind set, some portfolio
managers are selling riskier bonds and replacing them
with safer ones because of concern about market
liquidity, or the capacity to quickly buy or sell
securities at or near quoted prices. Many investors say
liquidity is drying up as the Fed pares its monthly
stimulus and large banks trim their bond inventories.
Investors pulled more than $5 billion in July from
U.S. junk-bond mutual and exchange-traded funds,
according to Lipper, a fund tracker, deepening the
liquidity fears and adding to concern that the recent
selloff could intensify…..
The downdraft in junk debt highlights concerns that
purchasers in the $1.6 trillion U.S. market, lured by
higher income than on government and highly rated
corporate bonds, have paid too much for the securities.
Prices have rallied, sending yields to levels too low to
compensate buyers for the risk of the investments, many
The tremors are being closely scrutinized across Wall
Street. Many investors this year have expressed concerns
that a pullback in junk-bond prices could signal that
market participants are rethinking their willingness to
take risk, foreshadowing further declines in stocks and
other risky assets.
The conditions are heaping extra pressure on sellers
at a time when geopolitical unrest from Israel to Ukraine
has caused a pullback from stocks and all but the safest
debt securities. The Dow Jones Industrial Average has
dropped seven of the past eight trading days and is down
0.5% this year.
Jim Swanson, chief investment strategist at MFS
Investment Management, which oversees about $438 billion,
said he has been demanding extra yield on some bonds to
reflect the risk that selling could take longer, and
avoiding some less-liquid bonds. "There's a question of
what happens when everyone tries to sell [bonds] at once,
and I want compensation for that," he said.
Brian Connolly, co-founder of hedge fund Millstreet
Capital Management in Boston, which oversees more than
$200 million in assets, said he recently tried to sell $3
million of energy company bonds but couldn't find buyers
for three days. Typically such a sale takes a day at the
most, he said.
It has become increasingly harder to trade," he
for rest of article
Update: The Buckle Earnings - Stock Keeps Chugging