Corporate Bonds March to Their Own Drummer
Chris Shayne
Bond Desk Group
November 10, 2010
October was a month of anticipation on Wall Street. All eyes were on Washington DC, as the markets tried to figure out the impact of the elections on November 2nd, and more importantly, the Fed’s November 3rd decision to implement another round of quantitative easing.
During the first week of the month traders bet big on QE2, purchasing Treasuries with abandon and dropping long term yields. On October 8th, 10-year yields hit a new low for the year, falling all the way down to 2.38%.
But for reasons that aren’t completely clear, things changed in mid-October. 30-year rates increased substantially, closing above 4.0% for the first time since August. 10-year yields also increased, though not quite as dramatically. One explanation is that institutional investors decided that yields had overcorrected in anticipation of QE2, so they sold their positions before rates turned around.
Alternately, the smattering of positive economic news in October may have driven investors out of Treasuries and into riskier asset classes. Still another reason could be concerns about inflation.
Corporate yields (for odd-lot retail bonds), meanwhile, marched to a different drummer in October. While Treasury yields were surging during the second half of the month corporate yields were sinking like a rock. Median yields peaked at 4.63% on October 15th, and then spent the next two weeks falling to a low of 4.25%. This is an unusual situation, as corporate yields typically move in the same direction as Treasury yields.
The reason for the divergence is that corporate spreads also fell precipitously during October, peaking at 2.28% mid-month before falling to a low of 2.04%. Spreads are a proxy for the market’s view of credit risk (i.e., large spreads indicate concerns about credit risk and vice-versa), so falling spreads certainly could be a positive indicator about the health of the economy. Another possible explanation is that spreads fell due to supply/demand dynamics in the institutional market (i.e., increased demand among institutions compressed corporate spreads, which filtered down to retail investors.)
Whatever the explanation, retail investors seem to have noticed the trend, as trading patterns closely followed the change in yields. Corporate bond purchases peaked mid-month and then tapered off after that. And sales of corporate bonds increased substantially as yields fell. In fact, the ratio of buying to selling in October was 1.1, which is the lowest mark this year.
In October, buying patterns were largely unchanged. Financials continued to dominate the market, accounting for 55% of all trades. Likewise, the top 20 most actively purchased issuers accounted for 46% of all buying activity, the same percentage as last month. The top 20 most actively sold issuers accounted for 44% of all selling activity, also the same as last month.
For more information about retail trading activity in the corporate bond market during October, please see the BondDesk Market Transparency Report.
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