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Curatia Analysis for Thu, Feb 7

“Margin” Call: Bond Market Dynamics Encourage Action at the Fringes

While the themes of slowing growth and accelerating automation featured in 2018 fixed-income headlines, another, more overlooked trend has emerged in 2019: Issuers and investors alike are operating on the bond market periphery in search of deals.

Bond markets grew at their second slowest pace in 22 years (+4.6%) in 2018, according to ICE, as rising bond yields curtailed new issuances. Meanwhile, rising US national debt spurred Treasury new issues even as China pared its Treasury holdings amid growing trade tensions, creating a supply glut.

Sluggish economic indicators and jittery markets in the US and Europe have prompted central banks to pause their rate hike plans (discussed yesterday), creating a window of opportunity for issuers of riskier bonds to re-enter the market.

Those dynamics have conspired to stimulate action at the fringes of bond markets as investors pivot back to a risk-on footing.

In the past week alone, “serial defaulter” Ecuador sold $1B in new bonds, Greece moved past its troubled recent financial history to receive “blockbuster orders” for a $2.9B bond sale, and Uzbekistan elected to meet investors for a debut international offering.

Those developments reflect broader growth in emerging market sovereign bonds (+12.4% last year) which has outstripped that of developed market counterparts (+4.5%).

Emerging markets’ growing representation in the bond ecosystem has increasingly fragmented markets, creating opportunities for trading platforms like MarketAxess that promise access to fragmented liquidity.

A 2018 Greenwich study found that 70% of US investors trade EM fixed-income products electronically. The study points out that electronic bond trading platforms not only extend the reach and scale of bond trading but also help would-be international investors transcend language barriers inherent in voice trading.

US high-yield debt has likewise become a port of first call for voyaging bond investors, posting its biggest monthly gain in seven years in January.

The US market for private debt — an umbrella term for lightly regulated, infrequently traded loans of widely varying sizes — has also “‘exploded,’” per BAML head of high-yield credit strategy Oleg Melentyev, growing from $300B in 2010 to $700B at year-end.

Even the archetype of mainstream bond issuance that is the US Treasury has flirted with alternative approaches to funding a debt mountain projected to top $12T over the next decade. A committee of external advisors to Treasury Secretary Steven Mnuchin last month brainstormed solutions including inflation-protected debt, perpetual horizon debt, and zero-coupon bonds.

Taken together, those trends highlight an inevitable outgrowth of electronifying bond markets: diversification. For both investors and fixed-income platform providers, the burgeoning breadth of offerings presents derivative challenges such as unlocking liquidity and navigating what is already a notoriously dizzying diversity of securities.

For those reasons, quant-oriented bond ETFs have garnered greater attention lately. The idea of choosing a fixed-income investing strategy and letting algorithms plumb the abysmal depths of individual bond comparisons holds obvious appeal for investors.

While such nascent strategies still represent a small slice of fixed-income markets and have yet to distinguish themselves — underperforming their benchmarks according to one recent opinion piece — they nonetheless remain beacons of hope in a bond firmament brimming with possibilities.