OPINION: Buy Side the New Sell Side?

Terry Flanagan

The fixed-income market has been granted yet another stay from what some market participants and observers believe is an inevitable day of reckoning.

Yield on the 10-year U.S. Treasury note recently dipped below 2%, and the benchmark was at 2.3% as of Thursday afternoon. Those numbers aren’t especially notable in the context of the past four years, but they remain quite low by historical standards, and the 10-year yield continues to defy predictions that it will scream higher.

Put it this way: when the yield increased to 3% in the fourth quarter of 2013, most people would have said that one year later, 5% was more likely than 2%. There may have even been more support for 6% than 2%.

The long-awaited bond-market rout may come as central banks dial back on quantitative easing. Or, perhaps higher inflation will be the catalyst.

A more practical concern is, how would such a market dislocation play out? It may not be pretty, because big sell-side banks who historically have been the liquidity stalwarts have substantially downsized their bond-trading desks, amid tighter regulation and soft market conditions. So there’s no real blueprint, as previous bond swoons have happened with Wall Street as a backstop.

One speaker at Markets Media’s Sept. 23 conference said: “If spreads widen in a rising-rate environment and broker-dealers and banks aren’t able to take down positions as they used to, where will we all go for liquidity?”

More recently, a sell-side executive (in remarks not meant for attribution) told me: “One of the biggest concerns in the marketplace is the what-if scenario in corporate credit, as a function of bank balance sheets versus outstanding issues…The bank balance sheet has transferred over the years to the buy side, as evidenced by the number of trading platforms that have sprouted up.”

Indeed, there is no shortage of bond-trading platforms out there, some established, some new. And bank voice brokers still wield some clout.

The patchwork marketplace seems to perform reasonably well during normal market conditions, but what happens if and when everybody heads for the exits?

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