Three Chart Alarm: The Fed Has Set-Up The Corporate Bond Market For A Big Fall

Three Chart Alarm: The Fed Has Set-Up The Corporate Bond Market For A Big Fall (David Stockman’s Contra Corner, Aug 5, 2014):

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 trillion today.

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 it:

“Everyone is hoping to be first through the exit,” said Matt King, global head of credit strategy at Citigroup 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.

1 thought on “Three Chart Alarm: The Fed Has Set-Up The Corporate Bond Market For A Big Fall

  1. As interest rates go up, bonds become far less attractive.
    Putting your money into junk bonds is beyond stupid……

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