Pressure mounted on buy-side bond desks in August

Published on 3 September 2020

Credit markets in August have characterised by high levels of issuance and poor levels of secondary market liquidity. Digesting enormous new flows, with the Federal Reserve buying very little and de-risking in the markets is all having a massive impact. With expectations on new issues blown through already, September is looking ominous.

With such huge supply, it will be critical that new initiatives to automate primary market processes are in play as soon as possible, says Jim Switzer, global head of fixed income trading at Alliance Bernstein. At the same time, asset managers that are unable to trade efficiently and electronically in the secondary markets will struggle in this environment.

Dan Barnes Welcome to Trader TV, I’m Dan Barnes. Today we’re talking with Jim Switzer, global head of fixed income trading at Alliance Bernstein. We’re going to be discussing the credit markets, some of the challenges in liquidity and price formation that exist today and how electronic trading can improve efficiency. Jim, welcome back to the show.

Jim Switzer Thank you Dan, thanks for having me again,

Dan Barnes Jim, how are credit markets looking in this month?

Jim Switzer When you look at where the index is trading, we’re off the post-COVID-19 tights in 6-7-8 basis points. Nothing crazy. We are digesting enormous supply for the month of August. I want to say that our expectations were 75 billion. I think right now we’re at 145 billion. And that’s on top of 1.45 trillion that we’ve seen year to date, which has blown through any record we’ve ever had. Clearly the issual behavior coming out of COVID-19 was creating cash buffers, protecting themselves. Now it’s much more opportunistic. It seems like it’s more a maturity profile management. We’re seeing a lot more people issuing in the long end the market, which is steepening our curves. There’s another reason why the curve is steepening and that’s that the Federal Reserve has said that they’ll target 5 years and in. Now they bought very little, certainly relative to what the ECB has been doing over the years. But I think the bigger issue right now is the Fed’s credibility, their body language. And is there a Fed put in the market; so how much they bought is less relevant to the fact that they would be there. Third thing that I think is happening is the street is de-risk. When we look at big cover ratios, what percent of the time are they winning and are they covering? Those numbers are going down, which just tells us they’re being more selective. The market now is difficult. There’s less conviction and liquidity is poor. It’s difficult to blips to blops. It’s easy to buy supply. The street, their behavior in times like this is generally to take less risk, frame markets wider, and everything we’re trying to trade is off of a framed market. So as markets get framed wider, it’s much more difficult for us to trade. When you think about electronic trading and even the all-to-all trading, which has gone up considerably for us and is a bigger focus, we still need the sell-side. We still need that liquidity framework out there. So that’s certainly challenging and rightfully so. We’re coming into September after seeing the supply we saw in August, September expectations are a 125 billion. But what we’re really not sure is how much of that was pulled forward into August and how much of that is real and how much more opportunistic. So it’s a tricky situation right now.

Dan Barnes We’ve seen a number of proposals that would potentially alleviate some of the workloads that’s on the trading desks right now on the buy-side, handling this huge volume of issuance. Do you think that is a big challenge at the moment and to what extent do you think they’re going to provide a solution?

Jim Switzer We’ve seen technology innovations, efficiency hit us in a number of ways with the alternative trading platforms we have out there. Now they’re helping us create these platforms to allow us to do portfolio trading on it. We have direct connectivity with a number of our dealers. We ourselves have created an execution management system. The one theme in all of that is we have no connectivity on the new issue side other than a phone call, and that is a struggle. It would actually benefit the sell-side, the buy-side and the issuers, because when you get145 billion dollars of supply it’s very difficult for a trading desk and even the portfolio managers at that moment in time, to really think about secondary trading. So we tend to all move over to the primary side of the market, and that’s unfortunate. There should be simple solutions. Now, I do believe there is a consortium of banks that are pushing this forward.  In terms of when it should have been six months ago, but I’ll take it whenever it gets here. I’m agnostic to the solution, I just know we need a solution.

Dan Barnes Do you think buy-side trading desks will have learnt lessons from the volatility in March in terms of preparing themselves to use electronic trading more effectively if there’s volatility later in the year?

Jim Switzer Electronic trading is great, it’s easy and it’s at your fingertips, but when you’re trading billions of dollars of credit in any given month, it’s very difficult to recognize all the opportunities. And I think a lot of these trading desks are going to realize that the data aggregation tools, the optimization tools that you’re going to overlay,  that’s going to tell you what’s the investable universe at any given moment and how does that universe overlay on what you’re trying to do at any given time. If you have those tools, you’re going to be able to take advantage in that market, and look, we want to be in the electronic trading market. We certainly want to be in the arms of all markets. We want to be a price maker, we know that’s alpha-generating. So that is our goal. I think it’s a big reach for a lot of the subscale asset managers to be able to have those tools to be able to get in. So it’s a question of the haves and the have-nots, and this gets into the build-versus-buy, so what do we do? The other part of it is, where else is there liquidity? Really the only reason we’re in the position that we’re in today is because the Fed and the central bank intervention and the bazookas that came out, you have to question whether or not we can actually count on that every time we see a crisis. You know at some point we have to see a regulatory response to what happened through the COVID-19 crisis; whether that’s talking about daily liquidity, vendor pricing, leverage in the market, cross trading, alternative liquidity providers, I mean, I can go on and on and on and as a trading does, that’s what we’re asking ourselves. Can we answer those questions? What could this look like and how do we get out in front of that?

Dan Barnes Jim, thank you very much.

Jim Switzer No problem. Dan, thank you for having me.

Dan Barnes I’d like to thank Jim for his expertise and of course you for watching. To catch up on our other shows go to TraderTV.NET or ETFTV.NET.