01.29.2016
By Rob Daly

Bifurcated Bond Market Increases Systemic Risk

Unless the fixed-income market structure is fixed to improve its liquidity and efficiency it is heading towards another financial crisis, warned participants of Thursday’s Tabb Forum Fixed Income 2016 conference.

Susan Estes, president and CEO of OpenDoor Trading. attributes the current market-structure’s weakness to the stark bifurcation between ultra-liquid and illiquid issues, such as the on the run and off the run US Treasuries.

“High-frequency trading represents 60% of trading volume and that’s not real money,” she explained. “The market is broken for the rest of the curve, which is important since it’s the benchmark for the rest of the world.”

Susan Estes,OpenDoor Trading

Susan Estes,
OpenDoor Trading

Estes greatest concern that adoption of fixed-income exchange-traded funds only further increase the bond market’s systemic risk.

“When investors cannot get a basket of off the run bonds that trade the Barclays Aggregated Long Bond Index, they will grab an ETF, she noted. “But ultimately, there’s an underlying instrument and if we do not pay attention to the fact that the underlying instrument is priced against something that’s dysfunctional, we are setting ourselves up for another crisis.”

Estes suggests one possible solution of  copying Mexican regulators. “They attribute a certain amount of money to modify the curve. They monitor it and have a process in place to re-liquify it if necessary.”

For Anthony Perrotta, global head of research and consulting at conference host Tabb Group, does not see the bond market facing a liquidity challenge, but a pricing one.

“It’s more about whether assets are fairly valued and whether I can get in and out of positions fluidly,” he said. “I’d argue that someone would step in and value in the marketplace, which is quite different from 2008. That’s why I’d argue that there is not a liquidity crisis.”

Perrotta expects the fixed income market will evolve into a all-to-all trading model from the current bilaterally negotiated model eventually, but how the industry will make that quantum leap is still unknown.

Featured image via Stephen VanHorn/Dollar Photo Club

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