“I recognize the tremendous liquidity problems and the ups and the downs on a daily basis, or even on a minute basis, and it scares the hell out of me,” explained Bill Gross, head of the Janus Global Unconstrained Bond Fund. The media had crowned him “bond king” when he was still riding high, but then he was fired from Pimco, which he’d co-founded, and whose Total Return Fund was until recently the largest bond fund in the world.
Bonds with long maturities have gotten hit the most. Since the beginning of April, the 30-year Treasury Bond Price Index has dropped 9%, crashing through the 50-day moving average and closing below the 200-day moving average on Friday. The yield rose to 3.1%, highest since October 2014.
Over the same period, the 10-year Treasury Note Price Index dropped 3.2%, crashing through both, the 50-day and 200-day moving average without taking a breath. The 10-year yield rose to 2.4%, also the highest since October.
Corporate bonds are facing a similar fate, or worse. S&P Capital IQ’s LCD HY Weekly reported:
The average yield across the Barclays U.S. Corporate Investment Grade index topped 3.3% this week for the first time since October 2013. It has increased roughly half a point over the last six weeks, including a rise of three-quarters of a point in the yield average across the long industrial component over the same span, to nearly 5%.
Average prices across that long industrial bond universe plunged to 106 handles this week, or 12 points lower in just six weeks, driving a total-return loss of roughly 9%. Long-dated securities have not been under comparable performance pressure since the second quarter of 2013….
Investors are beginning to lose some real money. A period when returns are not positive is generally considered a bond bear market. So this would be it.
“But I don’t think we’re in for a bear bond market just yet,” Gross told Bloomberg bravely, even as we hear hot air hissing out of the greatest credit bubble in history. It’s tough being a bond-fund manager when bonds with long maturities are officially scheduled for decimation.
But the global bond selloff and the Fed’s cacophony about raising rates fired up corporations to issue bonds at the fastest pace ever, before the endless sea of cheap money dries up. Though rates have risen, they’re still cheap and have a lot more room to rise. LCD HY Weekly:
The urgency is evident in the data, as 2Q-to-date issuance is running 38% ahead of the comparable 2014 total, and year-to-date issuance is 22% above the then record pace for issuance last year.
In the junk-bond arena last week, the majority of the deals were focused on financial engineering: acquisitions, spin-offs, or buyout activity. Despite endless complaints about “liquidity,” there was plenty of demand and no lack of liquidity. And the forward calendar, LCD said, is “bulging” with “acquisition-related blockbuster deals.”
Bond-fund managers love junk bonds. Hidden deep down in the fund where the unsuspecting retail investors can’t see them, they nudge up overall performance and make the manager look good, as long as the companies can hang on. Yet an ugly reality has emerged: In May, there were eight corporate-bond defaults and one leveraged-loan default, the highest by count since December 2009.
This elite list includes erstwhile rare-earth highflyer and media darling Molycorp, which owns the Mountain Pass rare earth mine in California. It went public in July 2010 at $14 a share. The stock soared on sheer hot air to $75 a share by April 2011, and then imploded. It’s now at 40 cents a share. Bankruptcy is next. An elegant wealth-transfer scheme.
Everybody conveniently blames “liquidity” and “regulations” for the debacle in the bond market.
Under pressure from regulators to lower their risk profile, big banks have been pulling out of market-making for bonds. According to Bloomberg, the New York Fed’s “primary dealers” – the 22 largest broker-dealers in the US through which the Fed interacts with the markets – have slashed their holdings of Treasuries from a record $146 billion in October 2013 to just $30.3 billion now. They’re no longer stepping into the market to buy Treasuries at prices where others don’t wants to buy them. That lowers liquidity when the selling starts. Or maybe, they’re the smart money and just don’t want to get caught with too many of these things on the way down.
Hence the increased volatility.
The irony? No one complains about volatility when asset prices soar; they only complain about volatility when asset prices drop. And no one complained when liquidity issues caused asset prices to soar because no one wanted to sell at these prices and the market makers refused to step in. Volatility and liquidity issues only cause conniptions among our Wall Street heroes and Fed geniuses on the way down, when buyers that still have any liquidity left are waiting for a better deal.
But here’s the thing: Liquidity magically reappears, often with a bang, when prices of good assets have dropped enough. And when crap sinks, it’s because it should have sunk a long time ago, and not because of liquidity. What liquidity-blamers are saying is simply this: we don’t want prices to drop to the level where enough buyers find them attractive; we want prices to remain artificially inflated.
“Volatility and repricing” – a euphemism for losses – are “part of getting back to normal,” explained UBS chairman and Bundesbank ex-president, Axel Weber. We should get used to it, he said, echoing what Draghi had said earlier. But what he’s fretting about is liquidity “under stress situations.” Read… Get Used to Selloffs, Central Bankers Say as They Fret about the Terrifying Moment When Liquidity Evaporates