Dealers absorbing junk bonds as ETF demand drops

‘Liquidity Mismatch’

Investors from retirees to pension plans and insurance companies are funneling cash into speculative-grade bonds, allowing companies to sell $188.8 billion of the notes in the U.S. this year, Bloomberg data show. More than 70% of the newly issued bonds are purchased by mutual funds, which are geared at individuals who may buy or sell their shares on a daily basis, according to BlueMountain’s Siderow.

That’s creating a “liquidity mismatch” because the funds buy longer-term debt, Siderow said. “Banks used to hold much greater inventory of bonds on their balance sheets and be liquidity providers to the market,” he said.

The new Fed data may not reflect the biggest banks’ capacity to facilitate trading in a sell-off, since the lenders may have significantly larger portfolios of high-yield bonds that are offset with hedges, Barclays strategists said in a May 17 report.

“When the market feels a little softer it’s a bit more likely dealers will have to provide that liquidity and expand their balance sheets,” Bradley Rogoff, head of global credit strategy at Barclays in New York, said in a telephone interview.

‘So Much Demand’

While market sentiment for high-yield bonds will eventually deteriorate, it won’t likely reverse anytime soon as central banks from the U.S. to Japan maintain bond-purchasing programs to stimulate the global economy, Youngberg said.

“There’s just so much demand for high yield it’s outstripping supply,” he said. “People think it’s painful now when they can’t buy; wait until they can’t sell.”

Elsewhere in credit markets, the cost to protect against corporate bond losses in the U.S. and Europe climbed to the highest in more than three weeks as a bigger-than-estimated increase in U.S. durable goods orders fueled concern that an expanding economy will prompt the Fed to scale back its stimulus efforts. Glencore International Plc and Vitol SA, the world’s two biggest oil traders, raised $8.3 billion in loans to fund their crude-purchase deal with OAO Rosneft.

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