Fixed Income Focus | Bob McDowall
“Retrenchment by investment banks and brokers in the fixed income sector is posing problems for asset managers seeking liquidity in secondary bond markets.”
key issue is that there is no consensus on the best business model for the future. Lack of secondary market liquidity has a direct impact on yields and the flow of debt issuance. As liquidity evaporates and capital providers are constrained, fewer market participants will be able to operate efficiently, leading to reduced competition. It will then fall to the buyside to provide that liquidity and they will require a greater incentive. Retrenchment by investment banks and brokers in the fixed income sector is posing problems for asset managers seeking liquidity in secondary bond markets. They have significant liquidity risk challenges in managing their fixed income portfolios on an active basis. In that environment electronic platforms, including single dealer platforms and multi-dealer venues run by independent operators, should benefit with managers looking for alternative ways to trade, but it is not providing the full solution.
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A growing divide The current eccentric monetary policies being pursued by central banks in much of the western hemisphere continue to bring price/valuation as well as supply/ demand distortions. The sector is witnessing highly visible divergence in economic growth prospects by geographic region. They pose critical investment implications in the years ahead for the US and Europe in particular.
The US Federal Reserve has been trying to strike a policy balance that both mitigates the deflationary impact of a variety of successive crises while at the same time containing the possibility of higher inflation. It has expanded its balance sheet by the policy of quantitative easing, as well as the maintenance of extremely low policy rate levels. In addition, the central bank’s bond purchasing in 2013 is likely to absorb most net US fixed income supply, further distorting markets and exacerbating supply/demand imbalances.
In the eurozone lending has declined. It is particularly weak in the corporate sector in Italy, Spain, and Portugal, where banks have instead rapidly increased sovereign debt holdings rather than lend. The region is continuing to deleverage despite rising unemployment and fragile consumer spending. This is not auspicious for a rapid return to growth. Temporarily at least, the European Central Bank has improved sovereign financing rates, which was critical to alleviating the crisis. The situation is different in the Asia-Pacific region. Japan is still trying to address structural difficulties, while the rest of developing Asia has strong growth prospects leading to an expansionary bond market. Initiatives are required to develop a pan-Asian bond market. This includes lifting the obstacles to cross-border capital flows and harmonising the regulations, withholding tax provisions, accounting practices, rating conventions and clearing and settlement systems that pose challenges for foreign participation in regional bond markets.
Most of Asia’s challenges within the fixed income market lie within its own grasp to resolve. By contrast the US and Western Europe are dependent on resolution of their economic and deficit problems. ■
*Bob McDowall, is consulting associate to commercial think- tank Z/Yen –
www.zyen.com.
Best Execution | Spring 2013
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