05.16.2013
By Terry Flanagan

Credit Liquidity Parsed

Buyers and sellers of company bonds are readily finding other sides for their trades, but macro tailwinds can turn into headwinds and dry up liquidity at a moment’s notice.

“With the global easing taking place, investors are desperately searching for additional yield and much of that money is flowing into corporate and high yield bond markets,” said Ramanathan Karthik, senior vice president and director of bonds at Fidelity Investments. However, “a reversal in Fed policy or a sudden negative shift to the economy could impact these investors if they have not carefully considered the creditworthiness of each investment.”

Karthik spoke at Markets Media’s Fixed Income Trading and Investing Summit earlier this week in New York. Themes of the event included buy-side challenges and opportunities, the continuing expansion of electronic bond trading, and the evolution of the retail side of the business.

But in a broad sense, it may not be an overstatement to say that the actions, or lack thereof, on the U.S. Federal Reserve and other central banks supercede all else in terms of importance for bond market participants.

“Global central bank easing versus the Federal Reserve’s potential reversal of its current policy is creating significant tension in the fixed-income markets,” Karthik told Markets Media in an e-mail prior to the May 14 conference. “While some investors believe the Federal Reserve will soon taper its mortgage and Treasury purchases programs given the recent positive employment news, many others feel such a move would be premature. In particular would such a tightening in the face of fiscal contraction and slowing global growth be poorly received by asset markets?”

“At the same time, the search for yield is incentivizing investors to purchase less creditworthy investments and is pushing assets into equity markets,” Karthik continued. “Once again, any reversal of Federal Reserve policy would impact both equity and fixed-income markets.”

On a fundamental, security-selection  level, bond investors are finding it especially challenging to identify investments with attractive risk-reward characteristics, Karthik noted.  “Judging investments by yield alone ignores the inherent risks associated with any credit investment,” he said. “If investors aren’t compensated for the risk they are taking by purchasing these securities, then the potential for negative outcomes dramatically increases.”

At least for now, liquidity isn’t a big issue. “Fixed-income markets remain robust as summer approaches, with strong issuance and primary market liquidity,” Karthik said. “Demand in the primary market has been significant, with many new issues oversubscribed by two to three times.”

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