Bloomberg -- The worst losses in U.S. debt in at least 37 years are being magnified by investors exiting the market at the same time new regulations prompt Wall Street firms to cut back on trading corporate bonds.
Bank of America Merrill Lynch’s U.S. Broad Market Index is on pace to drop 4.45 percent, the biggest annual loss since at least 1976. Investors pulled $123 billion from bond funds since May, according to TrimTabs Investment Research.
Trading in corporate fixed-income securities is the lowest ever as a proportion of outstanding debt, and volumes in Treasuries are little changed from 2007 levels even though the market has almost tripled to $11.5 trillion, Financial Industry Regulatory Authority and ICAP Plc data show. Bonds are getting riskier even with inflation at bay and corporate profits hitting new highs.
“When bond investors start to meaningfully divest themselves of their positions, it will be analogous to yelling fire in a crowded theater,” Michael Underhill, the chief investment officer at Capital Innovations LLC, which manages $1.5 billion, said in an e-mail Aug. 23.
Investors say it’s becoming harder to quickly exit positions as banks cut inventories and curb riskier businesses such as trading with their own money to comply with rules from the Basel Committee on Banking Supervision and the U.S. Dodd- Frank Act.
Money managers who used an average of seven dealers for the biggest purchases and sales of investment-grade securities in 2009 now say they need nine or 10, according to Stamford, Connecticut-based financial advisory firm Greenwich Associates.
Dealers globally have cut more than 500,000 jobs in the past five years. The credit-default swaps market has contracted 29 percent to $2.14 trillion of net outstanding positions since October 2008, reflecting the reduced trading, according to data maintained by the Depository Trust & Clearing Corporation.
The shrinking derivatives market makes it more difficult for dealers to hedge, reducing their willingness to own bonds, according to Jeff Meli, the co-head of fixed-income, currencies and commodities research at Barclays Plc in New York.
“The question isn’t how much risk you can move in a good market, but how much risk can you move in a down market,” Meli said in a telephone interview Aug. 26. “Liquidity will remain challenging. The forces that are pushing liquidity lower will only get more severe.”
That’s especially concerning to investors following a borrowing binge spurred by the Federal Reserve, which has kept interest rates near zero since Lehman Brothers Holdings Inc. collapsed in 2008 and pumped more than $2.5 trillion into the financial system. It’s currently buying $85 billion of bonds every month.
The face value of securities in the Bank of America Merrill Lynch U.S. Broad Market Index has grown to $19.2 trillion, up 61 percent from $11.9 trillion at the end of 2008. Speculative- grade, dollar-denominated debt now exceeds $2 trillion, doubling the past seven years, according to Morgan Stanley.
Bond investors, after enjoying annualized returns of 6.3 percent from the end of 2008 through last year, are now suffering as the Fed considers reducing its stimulus.
Yields on 10-year Treasury notes, a benchmark for everything from company bonds to mortgages, jumped to 2.93 percent on Aug. 22, the highest level since July 2011 and up from this year’s low of 1.61 percent on May 1.
Government bonds have retreated on the Fed’s plans, not because of inflation. The Commerce Department’s price index tied to spending, a gauge tracked by Federal Reserve policy makers, increased 1.4 percent in July from the same period in 2012.
Yields ended Aug. 30 at 2.79 percent, down 3 basis points on the week, or 0.03 percentage point, as the threat of a military conflict with Syria bolstered demand for government debt as a refuge. The price of the benchmark 2.5 percent note due August 2023 ended last week at 97 17/32, Bloomberg Bond Trader prices show.
Corporate bonds yields in the U.S. rose to 4.18 percent on Aug. 30 from a record low of 3.35 percent on May 2, Bank of America Merrill Lynch indexes show. Borrowing costs rose even as companies grew more creditworthy. Earnings of Standard & Poor’s 500 companies surged to more than $100 per share last year from about $60 in 2008 and default rates hold below 3 percent.
Borrowing costs may rise even more. Treasury 10-year yields will jump to 3.2 percent by the end of next year, based on the median estimate of 51 economists and strategists surveyed by Bloomberg. In April, the forecast was for 2.8 percent.
Investors are pulling unprecedented amounts of cash from bond mutual and exchange-traded funds after pouring $1.2 trillion into them in the three years after 2009, according to an Aug. 20 report from TrimTabs in Sausalito, California.
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