Stability-Liquidity Tradeoffs in Post-Crisis Bond Markets PRE- SET TEMPLATES & USAGE TIPS Darrell Duffie Graduate School of Business, Stanford University Brookings, November 17, 215
A stability- liquidity tradeoff Capital and ac6vity rules have improved bank stability and reduced commitments of bank- affiliated balance sheets to financial market intermedia6on. This raises incen6ves for agency intermedia6on, CCPs, all- to- all trade, shadow- bank intermedia6on, and a shid by banks away from low- risk standardized (low- margin) products. The net impacts on market efficiency are s6ll playing out, and depend on other factors, including monetary policy.
Treasuries bid- ask spreads are stable 9 2- year 5- year 1- year 8 7 6 256ths 5 4 3 2 1 1/1/25 1/1/27 1/1/29 1/1/211 1/1/213 1/1/215 Source: Adrian, Fleming, Stackman, and Vogt (215) (BrokerTec data)
Treasury note trade price impacts 2- year 5- year 1- year 18 15 256ths per $1 million 12 9 6 3 1/1/25 1/1/27 1/1/29 1/1/211 1/1/213 1/1/215 Source: Adrian, Fleming, Stackman, and Vogt (215) (from BrokerTec data)
Symptoms of changing liquidity Tradi6onal liquidity measures such as price impact and bid- ask spread look fine. Turnover and trade sizes are generally down. Single- name CDS and matched- book repo markets are withering. The 1- year Treasury note yield crash of October 15, 214 is a symptom of changes in the mix of intermediaries, including HFT.
Trade size has declined 2- year 5- year 1- year 25 2 Millions of Dollars 15 1 5 1/1/25 1/1/27 1/1/29 1/1/211 1/1/213 1/1/215 Source: Adrian, Fleming, Stackman, and Vogt (215) (BrokerTec data)
Treasury market turnover.14.12 Daily volume/outstanding.1.8.6.4.2 Data source: SIFMA
$ millions 2 Year 5 Year 1 Year 9 8 7 6 5 4 3 2 1 24 26 28 21 212 214 Note: 21-day moving average; 8:2-15: ET Source: Staff calculations, based on data from CME Group.
Decline in GCF net lending volume $ billions 1 8 6 4 2-2 -4-6 -8-1 Daily Net Cash Positions by Dealer Group Monthly Average Mar 11 Sep 11 Mar 12 Sep 12 Mar 13 Sep 13 Mar 14 Sep 14 Mar 15 Sep 15 month Non-BHC Dealers Small BHC dealers Large BHC Dealers 21
Corporate bond average bid-ask spreads $1.4 $1.2 Investment Grade High Yield $1. $ per unit par $.8 $.6 $.4 $.2 $. 22 24 26 28 21 212 214 216 Copyright 214 FINRA
Corporate bond average trade size 2. 1.8 1, Most Active Bonds Less Active Bonds 1.6 1.4 1.2 $ million 1..8.6.4.2. 22 24 26 28 21 212 214 216 Copyright 214 FINRA
Turnover of corporate and municipal bonds Daily volume/outstanding.8.7.6.5.4.3.2.1 Municipal bonds Corporate bonds Data source: SIFMA
6 When more dealers compete, corporate bond trade costs go down Investment Grade 5 4 High Yield Cost in Basis Points 3 2 1 1 2 3 4 5 6 7 8 9 1 11 12 13 14 15 16 17 18 19 2-1 Number of dealers responding Source: Hendersho` and Madhavan (214)
Number of CDS trades per quarter 4, 35, Single- Name Index 3, 25, 2, 15, 1, 5, Data source: DTCC
Who handles U.S. bonds? 4 35 Bond Fund+ETF Dealer Bonds Financed Assets (billion USD) 3 25 2 15 1 5 21 22 23 24 25 26 27 28 29 21 211 212 213 214 Data sources. ICI: AUM, bond mutual funds + ETFs. FRBNY: primary dealer daily financing (securi6es out) of UST + agencies + MBS + corporate bonds.
Net monthly cash inflows to bond funds 4 2 Billions of dollars - 2 1/1/13 3/1/13 5/1/13 7/1/13 9/1/13 11/1/13 1/1/14 3/1/14 5/1/14 7/1/14 9/1/14 11/1/14 1/1/15 3/1/15 5/1/15 7/1/15 9/1/15-4 - 6-8 Data source: Investment Company Ins6tute
$ billions 1 8 6 4 2-2 -4-6 -8-1 24 26 28 21 212 214 Note: Total net monthly flows; Some funds own agency debt securities and MBS in addition to Treasury securities Source: Staff calculations, based on data from Morningstar.
Asset management stability issues Comments on the risk of a crisis arising from sudden bond fund redemp6ons seem exaggerated. A rush for the exits would impact prices, but bids will likely arrive before a crisis is triggered. Who exactly would fail? Large hedge funds present a poten6al for unwind risk, given their reliance on leverage and expert porkolio managers. Large agency- based managers seem more benign, and have not been designated as SIFIs. Regulators also focus on insurance firms that are ac6ve in financial markets. Some have been designated. Money- market funds are migra6ng to government securi6es
Supplementary content
Depth has declined from recent highs 25 2- year 5- year 1- year 2 Millions of Dollars 15 1 5 1/1/25 1/1/27 1/1/29 1/1/211 1/1/213 1/1/215 Source: Adrian, Fleming, Stackman, and Vogt (215) (from BrokerTec data)
T- note mul6lateral plakorm volumes Daily volume (billions of dollars) 6 5 4 3 2 1 1- year 5- year 2- year 21 22 23 24 25 26 27 28 29 21 211 Source: Fleming (214) (BrokerTec data)
FX dealer versus non- dealer volumes Daily trade volume (billions of USD) 35 3 25 2 15 1 5 Dealers Non- dealers 1995 1998 21 24 27 21 213 Source: Rime and Schrimpf (214) (BIS data)
Some remaining system vulnerabili6es Improving but s6ll fragile design of tri- party repo leaves the poten6al for repo fire sales. Lending of last resort is overly limited by Dodd- Frank. Poten6al for pro- cyclical margins, pending new FSB standards (more research needed).
U.S. tri- party repo collateral and liquidity Type (9th percen6le haircut) CMO Treasuries (2.%) Agency MBS (3.%) Agencies (3.%) Agency CMO Agencies Agency MBS Treasuries Money market (5.%) Agency CMO (11%) IG Corporate (9.%) Equi6es (15.%) HY Corporate (15%) CMO (Private) (2%) Other Data source: FRBNY, November, 215 h`p://newyorkfed.org/data- and- sta6s6cs/data- visualiza6on/tri- party- repo/#interac6ve/volume
US GSIFI FHC Zone of stays on failure terminanon of swaps, repos, sec- lending U.K. Broker Dealer U.S. Broker Dealer U.S. Bank Counterparty
Daily average volume of interest rate deriva6ves 16 US- OTC US- EXCH UK- OTC Daily average volume ( $ billions) 14 12 1 8 6 4 2 1995 1998 21 24 27 21 213 Data sources. BIS: OTC Triennial (April), U.S. exchanges Table 23A (March).