Newsmax TV & Webwww.newsmax.comFREE - In Google Play
Newsmax TV & Webwww.newsmax.comFREE - On the App Store
Tags: hidden | bond | market | danger | 2 trillion dollar | wipeout

Hidden Bond Market Dangers Expose Traders to $2 Trillion Wipeout

dollar symbol in middle of bear trap

Friday, 12 April 2019 08:22 AM EDT

Behind the rally in global debt markets lurks a disaster just waiting to happen. At least, that’s what some long-time market watchers are warning.

While dovish comments by the Federal Reserve and other central banks have prompted investors to pile back into bonds, two troubling developments could make buyers uniquely vulnerable to deep and painful losses, they say. One is the sheer amount of ultra-low yielding debt, which means investors have almost no buffer in the event prices drop. That’s compounded by the worry liquidity will suddenly evaporate in a selloff and leave holders stuck with losses on positions they can’t get out of quickly.

Granted, nobody is actually predicting when things will turn ugly in the bond market, and history hasn’t been particularly kind to the doomsayers. Still, the risk is real, they say, and caution is more than justified. By one measure, the amount of investment-grade bonds has doubled to $52 trillion since the financial crisis. And yields have, on average, fallen to roughly 1.8 percent, less than half the level in 2007. If they were to rise by a mere half-percentage point, investors could be looking at almost $2 trillion in losses.

“This is an element of hidden leverage that is not appreciated,” says Jeffrey Snider, global head of research at Alhambra Investments. “We are eventually going to have a shock.”

The current situation is a legacy of the easy-money polices enacted by central banks following the financial crisis. With interest rates at or near zero, governments and corporations went on a historic borrowing binge — and investors gorged on debt that yielded little in return. What’s more, rules to strengthen financial firms and curb their risk-taking meant the big banks now played a much smaller role as intermediaries, transferring more of the risk of getting in and out of trades onto investors.

These worries aren’t new, of course, but they’ve attracted fresh attention as the amount of negative-yielding debt has climbed past $10 trillion. To some, it’s a sign investors have gotten a little too complacent and could easily get blindsided once growth and inflation start to pick up.

One way to assess just how much risk has been built into the bond market is by looking at something called duration. Simply put, it measures how much the price of a bond moves relative to a move in its yield.

Currently, the duration of $52 trillion of investment-grade bonds tracked by Bloomberg globally stands at about 7, close to a record high. (Bonds with low yields and long maturity dates tend to have the highest duration.) That means if yields rose a full-percentage point, the bonds would lose 7 percent of their market value. For a half-percentage point jump, that works out to 3.5 percent, or a $1.8 trillion loss.

“The debt load in the world is so high now that it can’t withstand any historically-normal size of interest rate increases anymore,” says Stephen Jen, chief executive officer of Eurizon SLJ Capital.

The risk of getting left behind when everyone heads for the exits is something Elaine Stokes takes to heart. The Loomis Sayles money manager says when she screens for securities to buy, the ability to get out of the trade is a key factor. That concern was underscored by JPMorgan Chase’s Jamie Dimon, who wrote in his annual shareholder letter that investors face a “new normal” of reduced liquidity and heightened volatility because of tighter regulations.

“There are fewer market-makers out there and way more investment grade and sovereign bonds,” Stokes says. Even in Treasuries, the most-liquid market in times of heightened volatility, she says the ability to transact without moving prices has declined.

To be sure, you could make the case that dealers were never in the business of taking losses for their clients, and that you’d rather have investors take it on the chin than have banks freewheeling in the markets, which almost brought down the entire financial system in 2008. Or that reduced liquidity is a feature, rather than a bug. Plus, you rarely hear investors complaining that people aren’t willing to part with their bonds when prices are rising — only that they can’t unload their positions when they’re falling.

There’s evidence market depth predictably drops during bouts of high volatility, but the question rests on whether the situation is materially worse than it’s been in the past. An analysis by JPMorgan suggests that while liquidity in the Treasury market has actually improved from its lows, it’s still well below pre-crisis levels. In December, when investors sought out haven assets as equities sank, the bank’s analysis showed end-of-year market depth for Treasuries fell twice as much as the average in the previous five years.

That doesn’t bode well for less liquid, risk assets.

“The issue is whether there will be enough liquidity in asset markets when everybody wants to redeem funds at the same time,” says Nellie Liang, a former Fed staff economist, who’s now a researcher at the Brookings Institution. She sees the biggest risks in funds and ETFs for less liquid assets, like certain corporate bonds, leveraged loans and emerging-market debt.

Concerns about liquidity aren’t confined to debt. Even in the $5.1 trillion-a-day market for foreign exchange, illiquidity has manifested itself in a series of mini-flash crashes. Most recently, traders were blindsided by a seven-minute surge in the yen versus the dollar, which took place during the witching hour — a period between New York’s market close and the opening of trading in Tokyo when volumes tend to thin out.

Andrew Maack, head of foreign-exchange trading at Vanguard, says flash events have become more common as algorithmic trading programs begin to outnumber humans. According to JPMorgan’s annual survey, currency traders said liquidity will be the biggest daily challenge of 2019. To JPMorgan’s Chinedum Nzelu, concerns about liquidity really come down to being able to get in and out of trades “when it counts.”

Bianco Research’s Jim Bianco says extraordinarily loose monetary policies have buoyed financial markets for so long that investors might be lulled into a false sense of security.

“Right now, there’s a lot of support for these debt markets from the central banks,” he said. “But what happens when economies get stronger and the central banks want to get out, and so does everybody else? Then you really will have a problem on your hands.”

© Copyright 2024 Bloomberg News. All rights reserved.

Ultra-low bond yields and reduced liquidity could blindside investors and exacerbate losses once the market turns.
hidden, bond, market, danger, 2 trillion dollar, wipeout
Friday, 12 April 2019 08:22 AM
Newsmax Media, Inc.

Sign up for Newsmax’s Daily Newsletter

Receive breaking news and original analysis - sent right to your inbox.

(Optional for Local News)
Privacy: We never share your email address.
Join the Newsmax Community
Read and Post Comments
Please review Community Guidelines before posting a comment.
Get Newsmax Text Alerts

Newsmax, Moneynews, Newsmax Health, and Independent. American. are registered trademarks of Newsmax Media, Inc. Newsmax TV, and Newsmax World are trademarks of Newsmax Media, Inc.

© Newsmax Media, Inc.
All Rights Reserved
© Newsmax Media, Inc.
All Rights Reserved